NEW YORK (MainStreet) -- Redundancy is standard operating procedure for NASA space missions -- but for investing, not so much. Duplicate holdings don't serve much purpose in an investment portfolio, but, unfortunately, most of these drags on performance are hidden. It's called "overlap," and it's a hazard found in mutual fund and ETF holdings.
"The S&P 500 was Vanguard's flagship, the first index fund launched in 1976, and a lot of people use that fund," says Walter Lenhard, a senior investment analyst for the Vanguard Equity Investment Group. "But the most popular fund these days is our Total Stock Market portfolio. And there's a lot of overlap. If you buy both of those funds, you really have about a 75% overlap in large- and mid-cap names."
There are lots of companies - even whole sectors - that can be duplicated inside a mutual fund or ETF. That's not exactly in the spirit of diversifying. Investors buy index funds, thinking they have a broad market covered - but not realizing that two funds with totally different names can be duplicating an investment strategy. You may want exposure to emerging market stocks, but are you sure you want to double down?
Ask your investment advisor to produce a mutual fund holdings list on your portfolio. You may be surprised how many of your funds are holding Apple (AAPL), Bank of America (BAC) and Amazon (AMZN). That's not necessarily a bad thing; it's just a hint as to how much overlap may be occurring in your portfolio. In fact, two-thirds of the companies represented in the CRSP mid-cap index are in the S&P 500 large-cap index.
But the problem goes beyond investments classified by company size - large-cap, mid-cap, small-cap and so on - it can also be complicated by matters of style (such as growth and value) and sector (like technology and financials). In other words, a small-cap fund may be fishing in the same pond as your technology fund. That large-cap mutual fund is buying the same stocks as your S&P500 index ETF.
And with overlap comes a gap.