Jim Cramer is on a campaign to reform the mutual-fund industry by
investing $125,000 in 50 funds.
Cramer's idea is to give himself a stake in the mutual-fund game by putting his money where his famous mouth is.
One danger is confusing an experiment with an investment strategy. It would be insane for the average investor to follow Cramer's lead and shell out six figures for stakes in 50 funds. Here's why.
Multiple Funds Mean Mediocrity
You don't need to own 50 funds. Frankly, you don't need more than 10.
You probably wouldn't go out and buy 50 funds in a single shopping spree. But over time, it's certainly possible to accumulate that many or more.
"I've actually spoken to people who own more than 50 funds," says Peter Di Teresa, senior editorial analyst at
. "At some point,
these investors become collectors."
Maybe you bought
Marsico Focus and
Marsico Growth & Income after celebrity manager Tom Marsico left
in 1997. But you kept
Janus Twenty and
Growth & Income out of devotion to the Denver fund company. Then you bought
Janus Global Technology when it came out in early 1999 and have since added
Strategic Value and
Maybe you've also picked up a couple of Internet funds and a few fleetingly popular aggressive-growth portfolios. Along the way you've assembled a dense collection of too many funds that are too much alike.
The idea behind building a portfolio of several funds is to temper the risk and volatility. You don't need more than nine or 10 funds to do that.
Morningstar conducted a study a few years ago to examine how the number of funds in your portfolio affects the overall standard deviation -- a measure of volatility. The conclusion: A portfolio's volatility falls until you hit nine funds and then it levels off. You get all the risk control by owning between four and nine funds in one portfolio.
"If you have 20 or 30 funds, it makes no difference in terms of standard deviation," says Di Teresa. "After about 10 funds, you're getting average returns. It's as if you found the perfect average fund and own that."
With too many funds, you aren't reducing the risk. In fact, you're only increasing your chances of having a truly ordinary portfolio. Plus, you'll have a harder time monitoring your funds' progress and sifting through the loads of mail the funds ship you.
Too Much of a Good Thing
Not only should you be wary of owning too many funds, you should avoid putting too much of your money in any segment of the market. You want exposure to both growth and value stocks, both large and small.
Of the 50 funds in Cramer's list, almost half are large-cap funds, while only two of his selections invest in small-cap stocks, according to data from
. Of the 22 large-cap funds on the roster, 16 are large-cap growth funds.
Of course, Cramer wasn't trying to construct a well-balanced, perfectly allocated portfolio when he was picking these funds. You, however, need to worry about such things.
Since you never really know which part of the market will outperform at any one given time, you should keep about half your money in growth stocks and half your money in value. You should probably also have a percentage of your assets in small-cap stocks.
After all, approximately 23% of the
, a measure of the entire U.S. market, is made up of small- and mid-cap stocks. That index is a good benchmark for what your overall portfolio should look like. Even then, you'd still be missing bonds or international stocks.
You also have to worry about widespread overlap in the holdings of your various funds.
If you've got most of your money in large-cap growth funds, you're probably going to own a lot of
Of the 16 large-cap growth funds in the Cramer list, Cisco shows up as a top-10 holding in 13 of those names. (That's not even including the 10 tech-only funds he bought.)
If you own a collection of funds, you cannot easily track what all of those funds own at any given moment. For one thing, most of the portfolio information you get from fund companies is dated -- so dated you'd almost expect to find
as a prominent holding.
Rather than digging through each fund's holdings, you can closely watch your funds to see if they move in unison. This repetition often occurs among funds within one fund family, such as at
Garrett Van Wagoner's firm.
"There's no reason to have a lot of funds doing the same thing," says Di Teresa. "Odds are, some are better than others."
If your funds move closely together, you know they probably own a lot of the same stocks. If tech stocks do well one day or week and all of your funds move in the same direction, they are all relatively similar. Then, it may be the time to go buy an energy fund.
A Sales Charge Without the Advice
Cramer is buying more than a dozen load funds. These funds -- typically sold through brokers and advisers -- come with a sales charge.
Part of Cramer's idea is to own some funds run by the big well-known fund families. When he was picking these funds, he wasn't worrying about paying a load or not.
But the average investor should be concerned. If you aren't getting any financial advice or unique benefits in exchange for paying this sales charge, you should look elsewhere.
Why buy a large-cap growth fund with 5.75% front-end load when you can pick up an
index fund without the commission?
You're basically giving your money away and getting nothing in return.
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Dear Dagen aims to provide general fund information. Under no circumstances does the information in this column represent a recommendation to buy or sell funds or other securities.