Not that many years ago planners and brokers recommended to clients that they choose only one fund as their core mutual fund and then build satellite holdings around that core. The core would exemplify exactly what the client was attempting to do with their investment goal. If they were conservative and wanted preservation and income the core fund could have been a Bond Mutual Fund or Stable Value Fund. If the client desired growth the core fund could have been a world mutual fund or a large cap growth or value fund.
Morningstar, the analysis and reporting company, aided investors by noting which funds were appropriate for Core holdings and which were not.
Once the core fund question was established additional mutual fund investments were added that either augmented or enhanced the client’s philosophy and goal. These funds could have been small cap, technology or mid-cap, among the dozens of offering.
Jack Bogle, of Vanguard fame, first suggested only holding two funds in any investment plan; one the S&P 500 index mutual fund and the other a long-term Bond Mutual Fund. Later, when the S&P 500 languished for an entire decade with little or no returns he revised his equity holding to the Total Stock Mutual Fund which held over 3,000 individual stocks in its portfolio.
A Core fund holding usually held a massive percentage of the total portfolio-sometimes as much as fifty percent. Of course things have changed and investors today do not like putting all their eggs in one big basket and prefer to spread their assets among many different but similar funds. This creates another problem.
By buying funds and ETFs that have similar investment philosophies investors run into a problem called stock overlap. I’ve been noticing this even when examining my client’s holdings within one fund family. A mutual fund management firm will buy a trainload of XYZ stock at a cheap price and parse it out over several in-house funds. An investor who allocates between a world fund and a domestic growth fund, and using them as the Core, would expect the funds not to act in the same like-manner but are surprised when they do act almost in concert. The reason is that many of the largest holdings in each of the funds is overlapping because of the huge amount of stock the fund family bought and how it allocated that one stock to the various fund managers in the various funds they managed.
In order to minimize stock overlap investors need to move out from a single fund family and invest in altogether different mutual funds within their selected comfort range. There may still be a slight overlap because of the limited number of investment options but not as severe as that within one fund family.
A few years back it may have seemed silly to buy several funds from several different fund families with identical investment goals. It is for the same reason that Bogle gave up on his S&P-500 Index forever mantra and switched to the Total Stock Fund. Investors get a wider and broader allocation with minimal stock overlap.
Core investing has gotten a facelift. Today’s investor is perfectly fine with buying large cap value, growth or blended funds from several mutual fund families and integrating them as their Core. From that beginning they can add as many sectors as they desire to complete their plan. The goal, after all, is to minimize losses, reduce volatility and increase total return. By minimizing overlap investors can get reduce much of the portfolio ups and downs and get better diversity.
Questions call Paul @ 877 783 7080 or write him at pstanley@westminsterfinancial.com. Share this blog with someone who cares about their money.
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