Too many portfolios are overloaded with similar investments. Sadly, few investors know very much about overlap.
A frequent investing theme of today is owning more than a dozen mutual funds. Often purchased over the years with little thought as to how the collection fits together, if at all.
Owning several funds can result in creating significant “overlap” of securities. That is, individual holdings within the mutual funds are often the same, or quite similar.
While fund names differ, their holdings may not. For example, mutual funds buy from a short list of bank stocks.
Having several accounts can also result in owning many of the same stocks in each. This may tilt your portfolio in one or more asset type or sector.
However, I hardly see anything written about portfolio overlap. No wonder most investors have little or no knowledge of the implications of overlap.
I highlight what can happen:
- Owning a collection of funds heavy on overlap reduces portfolio diversification.
- Overlap increases if you choose funds from similar investing styles and sectors.
- Portfolios that overindulge on overlap can affect their long-term results.
Some portfolios I’ve reviewed were sporting more than 40% overlap. I’ve seen issues arise with as little as 10% overlap.
Think of your overlap in this fashion:
|Overlap Factor||Overlap Range||Portfolio Implications|
|Low||Under 10%||Little required|
|Noticeable||10% to 20%||Needs tweaks|
|Medium||20% to 30%||Cracks showing|
|High||30% to 40%||Serious problems|
|Excessive||Over 40%||Start fresh|
I present five straightforward ways to reduce the impact of portfolio overlap:
1. Design personal asset mix targets and invest within them.
Something few investors have or follow.
2. Focus on portfolio diversification to achieve the least duplication.
Start by analyzing stock similarities in your mutual funds’ top holdings.
3. Be careful when buying funds from the same manager or provider.
This is when portfolio overlap can reach its highest levels.
4. Invest in Exchange Traded Funds (ETFs) and index funds.
Up to twelve ETFs with low or no overlap should suffice to populate most asset mix.
5. Reduce the number of investing accounts to a minimum.
Then concentrate on how well the investment selections mesh together.
Probe the overlap factors affecting your nest egg. Try to keep duplicate and similar holdings as low as possible.
Limiting overlap also reduces portfolio risks. You can’t avoid all overlap as many funds invest in the same companies.
Your primary mission is to minimize overlap, not eliminate it. Don’t allow the consequences of overlap to shortchange your portfolio.