Charles Schwab & Co., which has largely built its reputation on the thousands of mutual funds it offers investors, is now warning that investors can own too many funds. The brokerage's Schwab Center for Investment Research recently published a study that says investors should only own ten funds - three in each asset class and one bond fund. Otherwise they have redundant investments and pay too much in management fees. The study also says that investors should own just one index fund per asset class.
"Holding too many funds can eliminate the chances of market-beating performance as your portfolio begins to behave more and more like its benchmark index but at a much higher cost than a real index fund," the study said. For the study, Schwab created thousands of hypothetical portfolios using three different asset classes- small-cap, large-cap and international. Different numbers of funds were used in the portfolios and their returns were compared to index returns.
"Choosing 10 funds virtually eliminated the risk of drastic under-performance but also virtually eliminated the potential to outperform the market," the study concluded. Schwab officials warned investors against using its findings too rigidly. "This rule of three is a rule-of-thumb, an investor still needs to apply the same rigorous criteria and due diligence in selecting an individual fund as always," said Mark Riepe, head of the center and an author of the study, in a statement. Investors should also diversify within asset classes, such as varying between investments styles, the study said.