The overlap trap: Can you have too much of a good thing?
May 27, 2014
Sometimes building an investment portfolio feels like ordering a meal in a restaurant. You look over the menu and choose items that are appealing for one reason or another.
Many mutual fund investors do the equivalent of ordering the exact same menu item over and over again without realizing it. How? By owning shares of different funds that invest in the same securities. For all of their advantages—and there are many—mutual funds can make it easy to unintentionally acquire overlapping positions in stock or bond offerings.
A little duplication isn't necessarily a bad thing. Because mutual funds invest in hundreds or even thousands of different securities, the chances of your portfolio being affected by overexposure to one particular stock or bond are small.
Consider a large, well-known U.S. company like Johnson & Johnson. As of April 30, 2014, "J+J" stock was included in more than 35 Vanguard mutual funds and exchange-traded funds (ETFs). If your portfolio includes (hypothetically) Vanguard 500 Index Fund, Vanguard Windsor™ II Fund, and Vanguard Growth and Income Fund, you'd own Johnson & Johnson shares (indirectly, given the way mutual funds operate) in three separate fund accounts.
And this is hardly an unusual case. You'd find shares of both Microsoft and Apple in more than 30 Vanguard fund products. Ditto for retail giant Wal-Mart. Yum! Brands (owner of Taco Bell, KFC, and Pizza Hut) is in 20 of our funds. Coffee kingpin Starbucks is in 19. PepsiCo is in 29. General Electric is in 26.
Cause for concern? Maybe not
Everywhere you look, it seems, mutual funds overlap each other. So what's an investor to do?
Well, for starters, don't overreact. A little duplication isn't necessarily a bad thing.
Take another well-known American company: General Motors. Although GM stock is present in nearly two dozen Vanguard funds and ETFs, it isn't ranked among the top ten holdings for any of them. In fact, GM shares represented less than 1% of the total assets managed by all but one of our funds—Vanguard Consumer Discretionary Index Fund, which had about 1.6% of its portfolio invested in GM as of April 30. Because mutual funds can invest in hundreds or even thousands of different securities, the chances of your portfolio being affected by overexposure to any one particular stock or bond are small.
The real problem, at least in terms of reducing your diversification and increasing your risk exposure, is that you might have a long list of stocks or bonds—not just one or two—lurking amid multiple funds.
That's why it's important to know what you own. Fortunately, vanguard.com makes it easy.
For example, say you own shares in Vanguard Total Stock Market Index Fund. As of April 30, 2014, this fund had almost 3,700 separate holdings. A quick look at its Portfolio & Management page shows you the fund's ten largest positions as of the most recent month-end. Or you can go deeper and view a complete list of everything in the fund, ranked by the shares' market value—14 million shares of Apple Inc., valued at $8.3 billion; 67.8 million shares of Exxon Mobil, valued at $6.9 billion, and so on. With a few simple calculations, you can gauge your personal exposure to a particular security.
Again, don't be surprised to see the same company or bond issue popping up in more than one fund. It's when you see truly significant duplication that you may need to step back, rethink the way your money is allocated, and make some adjustments by investing in funds with less overlap.
An all-in-one option
There's another way to reduce your odds of duplicating assets, and that's to invest in just one fund.
It may seem counterintuitive—putting all your eggs in one basket—but we at Vanguard think a single-fund approach can actually be a very effective way to invest. We offer a number of "all-in-one" funds that hold carefully chosen, diversified selections of existing Vanguard index funds, all tailored for particular investment goals and particular types of investors.
Our acclaimed Target Retirement Fund series, for example, is designed to help you build savings over the long term while keeping your risk exposure well contained. Each of the Target Retirement Funds gives you access to thousands of U.S. and international stocks and bonds, including exposure to the major market sectors and segments. As you get closer to retirement, the funds' managers gradually shift each fund's asset allocation away from stocks and toward bonds, making the fund more conservative over time. This frees you from the hassle of ongoing asset rebalancing.
Each of the Target Retirement Funds has an initial minimum investment of just $1,000, and their expense ratios are about one-sixth the cost of their peers—a savings of nearly 84%.*
Need some guidance?
If a single-fund option isn't right for you but you don't feel comfortable changing your holdings on your own and you'd prefer hands-on portfolio assistance, Vanguard is here to help.
Whether you plan to manage your assets by yourself, need a little professional advice from time to time, or want to build an ongoing partnership with a financial advisor, our investment professionals are available to listen and address your questions or direct you toward options that best suit your needs.
Working with Vanguard's advisory services means you'll get straightforward advice from professionals who receive no commissions and have only your interests in mind, and who will help you implement disciplined strategies rooted in Vanguard's commonsense approach of broad diversification, low costs, and investing for the long term.
You can learn more about our advisory services here or call us at 888-200-3109 for more information.
*Vanguard Target Retirement Funds average expense ratio: 0.17%. Industry average expense ratio for comparable target-date funds: 1.05%. Sources: Vanguard and Lipper, a Thomson Reuters Company, as of December 31, 2013.
- All investing is subject to risk, including the possible loss of the money you invest. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
- Diversification does not ensure a profit or protect against a loss.
- Investments in Target Retirement Funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in a Target Retirement Fund is not guaranteed at any time, including on or after the target date.
- Bond funds are subject to interest rate risk, which is the chance bond prices overall will decline because of rising interest rates, and credit risk, which is the chance a bond issuer will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline.