Top Investor Mistake #4: Thinking you're diversified when you're not.

I remember in early 2000, shortly after the Wall Street Journal had come out with their year end Mutual Fund review.  A woman walked in and had highlighted all ten of the "top performing stocks" for the prior 1 year.  Little surprise that they were all either Large Cap Growth funds or Tech funds.  She wanted to invest a little in each one of them.  To invest in only one or two didn't seem diversified enough for her.  I assure you that if we looked at the top ten holdings of each of those funds, you would see many of the same companies over and over.  I'm also sure that each of the funds on that list suffered mightily in the months and years to follow.

Of course this is more of a problem for mutual fund investors than individual stock investors.  However, even there, you will likely find investors grossly overweighted in particular sectors.  Tech, Energy and Biotech seem to be favorites for investors who like to overweight.

Let's take a look at the top ten holdings in the largest mutual funds in America.

#1  American Funds - Growth Fund of America, Class A:  GOOG, MSFT, LOW, SLB, TGT, MO, Roche Holding, AIG, Burlington, TXN

#2  Vanguard Index 500: GE, XOM, C, MSFT, PG, BAC, JNJ, AIG, PFE, MO

#3  American Funds - Investment Company of America, Class A:  MO, T, LOW, Burlington, TYC, GE, FNM, MSFT, TGT, SLB

So, they're not identical, but take a look at the first two.  They have completely different objectives; one is a large cap growth fund, the other is an S&P 500 Index fund.  Yet, three of the top ten holdings are the same.

GE and MSFT show up in all three, SLB, LOW, TGT, AIG and MO show up in two of the three.

Yes, the largest funds are likely to be large cap funds, causing more duplication.  However, how many investors do you think own multiple large cap funds for the sake of diversification?  Heck, many even own multiple Energy funds, Tech funds or Gold funds for the same reason.

The lesson:  diversification can be a very important tool to help reduce overall portfolio volatility, but learn to recognize the difference between true diversification and just adding another fund.

And most importantly, read my disclaimer:  This is general advice. You should consult with your own financial advisor before making any major financial decisions, including investments or changes to your portfolio.  You, alone, are responsible for any losses or damages that may and will likely result from your financial decisions.

Comments

[mapgirl]

Good point! I think a lot of people make that same mistake. I'll have to review what my mutual funds are holding sometime.