Avoid Fund Glut, cont'd
Keep Things Simple: You Don't Need Many Mutual Funds

By Werner Renberg

Of course, you may want to try to come closer to the equity index’s return by investing more in stocks, or you may want to invest in the municipal bond market if you are investing outside a tax-deferred plan and want to avoid the income tax you would owe primarily because of the Balanced Index Fund’s interest income distributions.

In that case, the reader’s suggestion wouldn’t be a bad idea at all.

It’s in line with a five-equity-fund portfolio suggested for "investors seeking active equity management" by John C. Bogle, founder and retired long-time CEO of The Vanguard Group, in his excellent 1999 book, "Common Sense on Mutual Funds" -- even if "a single ready-made balanced index fund…can meet the needs of many."

Like the reader, Bogle recommended three equity funds on the basis of the market capitalizations (or caps) of the companies whose stocks they own: large-cap, the core to which he would allocate 50 percent; mid-cap, 10 percent, and small-cap, 20 percent. He would split the remaining 20 percent between a sector fund -- such as health care, technology, or energy -- and an international fund, although he added that he is "not persuaded that international funds are a necessary component of an investor’s portfolio."

Like the reader, Bogle also would add a bond fund -- taxable or tax-exempt, depending on whether you are investing in a tax-sheltered plan, and short-, intermediate-, or long-term, depending on your risk tolerance.

"I truly believe that it is generally unnecessary to go much beyond four or five equity funds," Bogle wrote. "Too large a number can easily result in overdiversification. The net result: a portfolio whose performance inevitably comes to resemble that of an index fund." And if the portfolio is invested in actively managed funds instead of index funds, he added, "it will be riskier than the index. To what avail?"

Nearly a year having passed since the book was published -- a turbulent year in the markets, to be sure -- I asked Bogle whether he had changed his thinking. He had not, repeating his assertion that "you only need to own one (equity) fund:" one that captures the entire U.S. stock market by matching the Wilshire 5000.

He stands by his large allocation to a large-cap fund, even if small-cap stocks may do better in the foreseeable future, because he is reluctant to deviate from the roughly 75-25 split in market weighting between large-caps and the total of mid- and small-caps. "When you do that," he said, "you’re betting."

He has not changed his view on international funds, pointing out that the non-U.S. operations of U.S. companies give you ample exposure to the global economy.

Asked why his five-fund suggestion for people "who want complexity" did not include a value or growth fund, Bogle said, "If you think that growth is better than value or perhaps today you may think that value may be better than growth, you’ve got to think about…when are you gonna change…and why…The fat lady doesn’t sing.

"You’re betting that one will do better than the other over the next X years, when there’s a 50-50 chance the other one will do better. In the very long run, they both do the same." (In the last five years, the S&P 500/BARRA Growth Index led its sibling Value Index every year, producing an average annual return of 30.7 percent vs. 19.0 percent.)

Copyright © 2000 Werner Renberg. Reprinted with permission.

More articles by Werner Renberg can be found here.