When it comes to investing, diversity is key! This is why index funds, which provide various stocks and bonds, are so valuable for traders. Since these funds already consist of different investments, you might wonder how many you should have.
The number of index funds you should own depends on the funds themselves and your strategy. Owning various index funds can be effective, but sometimes just one is enough. The two types of index funds (mutual funds and ETFs) have different pros and cons in this regard.
Understanding the differences between index funds and how they apply to you is vital for new investors. Read on to learn how you can build the best index fund portfolio for your needs.
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Number of Index Funds To Own: What To Consider?
Determining how many index funds you should own depends on which funds you are acquiring. Your overall investment goals and strategy also influence the number.
Let’s start by examining the different types of index funds.
Index funds generally fall into two categories: mutual funds and ETFs (exchange-traded funds).
So how many should you own of either one? For starters, you generally need to hold fewer mutual funds than you would ETFs. The reason is mutual funds are typically broader, covering a more comprehensive array of investments than ETFs.
However, ETFs have specific advantages, like flexibility and low cost.
Both are mixes of various assets and securities, but they have some crucial differences to know.
An investing manager actively handles mutual funds, and they are only buyable at the end of trading days. Meanwhile, ETFs are passively managed and traded the way stocks are.
Below, this article dives into the two index fund types and how their differences affect your investing strategy.
How Many Mutual Funds You Should Own?
There is no magic number, but you typically need fewer mutual funds than ETFs. Often, less than a handful or only one mutual fund is enough.
This idea may seem contradictory since traders often hear how vital portfolio diversity is. To understand why owning numerous mutual funds is usually unnecessary, you should first know how mutual funds work.
Here’s a review of some basics.
When purchasing a share of a mutual fund, you partially own the fund and its profits. Fund managers actively buy and sell securities in these funds to provide the most significant profit possible.
They cost more than ETFs since you’re also paying for the workforce that runs the fund. This additional cost comes via fund fees, such as 12B-1 fees (as opposed to the commission). These extra costs are essential to consider when assessing how many and which mutual funds you desire.
Typical mutual fund costs range from a few hundred dollars to a few thousand per share. The mutual fund VTSAX currently has a minimum buy-in of $3000. With such a high entry point, you’ll likely not be buying as many of them as ETFs and stocks.
Why You Don’t Need Many Mutual Funds?
You don’t need a variety of mutual funds because many of them are already diversified. Not to mention mutual funds are actively managed and change with the market.
We will continue using VTSAX as an example.
In Vanguard’s words, VTSAX is a mutual fund that “is designed to provide investors with exposure to the entire U.S. equity market.” Index funds like these, or ones tracking leading indices like the S&P 500, are thus typically quite diverse.
While diversity is good in investing, too much of it is potentially detrimental. So, you ordinarily don’t want too many mutual funds.
Moreover, mutual funds have investing experts steer the fund towards profit. They account for changes in the market and morph the fund for optimal returns.
Plenty of investors trust just one or a few mutual funds to grow their profits better than they could. The alternative is buying a wider variety of ETFs and securities.
These investors place their trust well; many mutual funds historically hold outstanding track records of consistent profit. This is why top investment firms and companies often consider them a form of risk mitigation.
How Many ETFs You Should Own?
The number of exchange-traded funds you should own varies. Generally, anywhere from 5 to 10 ETFs can work for most investors. However, the best number for you will depend on the specific funds and your strategy.
You generally want more of them than you would mutual funds. But you don’t need to buy a variety like you might with stocks.
But why would you want a wider variety than you would with mutual funds?
Primarily because ETFs are narrower in scope and cheaper than other index funds. Also, ETFs are ordinarily passively managed. Meaning they don’t actively evolve the same way mutual funds do.
Unlike mutual funds, ETFs are tradeable like stocks. You can easily purchase a plethora of different ones from most brokers. Traders can also buy and sell options for ETFs during trading hours (assuming they have permission).
Why Do You Want More ETF Variety Than Mutual Funds?
As mentioned above, ETFs usually are narrower in scope than mutual funds. They cover specific niches and industries that mutual funds might not include.
Because of this, they track a smaller breadth of the market. So, you want to possess more exchange-traded funds to get adequate coverage and risk mitigation.
ETFs are also passively managed. They closely follow a set index or niche with consistency.
Investors thus might need to buy more of them over time to keep up with changes in the market. Mutual funds differ in this respect since fund managers can strategically reinvest for you.
How Your Trading Strategy Affects the Number of Index Funds To Own?
Your unique investment goals determine the best number of index funds to own. This is primarily because those goals steer you towards particular types of funds.
For example, you will probably prefer ETFs if you like being hands-on with your investments. Meanwhile, investors who want to set up recurring deposits and withdrawals might wish for mutual funds.
Keep in mind you can also have a mix of different types of index funds. It’s fairly common for experienced investors to own both exchange-traded funds and mutual funds.
Now let’s examine how index funds benefit certain circumstances.
How Actively You Trade?
First, consider how actively you want to trade index funds.
Want steady growth without too much hassle? A couple of mutual funds can be very effective to that end. But if you feel pumped to make big plays, then a basket of various ETFs is the way to go.
Investors add to mutual funds but generally don’t use them for trading actively. After all, you’re paying for an expert investment manager to handle the fund for you.
If you don’t want to participate in the market directly, owning a couple of mutual funds is a great option.
If you want to be more hands-on with your money, definitely go for ETFs. Exchange-traded funds work like stocks and thus have much more inherent flexibility. You’ll benefit from the variety of niches, but you also need to give them more attention.
Recurring Transfers and Retirement
Mutual funds accommodate recurring fund transfers well. For example, you could set up a weekly deposit into a single solid fund and essentially need nothing else.
That’s partially why mutual funds are perfect for consistent, long-term growth. A few well-kept mutual funds can potentially balloon into fruitful retirement funds over the years.
But what if your goals center on short-term profit, or you aren’t making regular transfers? In those cases, you’ll want a variety of index funds and probably more ETFs.
Due to trading like stocks, these funds often see a lot of price movement compared to mutual funds. So for astute investors, the recurring transfers aren’t as necessary if they make consistently profitable trades.
This strategy often benefits from a variety of ETFs, much like a diverse stock portfolio. And unlike mutual funds, exchange-traded funds are typically short-term investments.
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Conclusion
There’s no perfect number for how many index funds you should own. It depends mainly on the funds themselves and your investing strategy.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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