Over-diversification danger

Do you collect mutual funds? Unlike hobbyists who collect stamps, investors who own a multitude of funds are not better off.

While diversification is important to any portfolio, owning too many funds can make investing more complicated than necessary.

One of my clients owned 16 different accounts, including an array of stock and bond mutual funds. In all, he had 56 mutual fund positions. Everyone should be well-diversified, but this client had missed that mark.

A lot of folks are in the same situation: Their finances are a hodgepodge. Good financial advisers bring order to that mess and adopt a common-sense strategy for the long term.

Five years ago, the client, a doctor, came to me because he wanted to retire. His portfolio was sizable, yet he had no idea what he owned or why. "I simply don't understand what I have," he said. "Will I have enough cash flow in retirement?"

Here's what's wrong with owning too many funds and other investments:

Tracking them all is difficult. You should review all of your monthly statements. Following 16 accounts can be a nightmare. Rebalancing when your circumstances change or funds shift in value is a challenge. Fewer funds and accounts are much easier to handle.

There's little diversification, and risk isn't reduced. Ideally, a portfolio is sufficiently balanced so that if one asset suffers, others offset its losses. A study by Morningstar, the investment research firm, shows that owning more than four randomly selected funds decreases risk very little. Only a small difference exists between holding four funds and 30.

Figuring out where to get cash in retirement is a chore. Once retirement begins, you need to decide which accounts should provide your cash flow. Consolidated accounts make this process much easier.

In my client's case, around 80 percent of his portfolio was in stocks or equity funds. His portfolio looked like that of a 30-year-old, not a 70-year-old. We switched him to a 50-50 split between stocks and bonds.

As with most things, in the world of financial planning, simpler is better.