Comparing mutual fund holdings

Don TaylorQuestionDear Dr. Don,
I presently have two mutual funds in the same mutual fund family. I would appreciate your opinion on what percentage of overlapping companies you would consider too many?

The first fund has 203 holdings of which 45 duplicate the second fund, which has 141 holdings. What is your opinion on this amount of overlap?
-- Michael Multiple

AnswerDear Michael,
You provided me with some additional information about these investments. The two mutual funds are Royce Low-Priced Stock Fund, or RYLPX, and Royce Value Plus Fund, or RYVPX. You have roughly $2,500 invested in RYLPX and it's held in a traditional IRA. You have roughly $2,700 invested in RYVPX and it's held in a Roth IRA. Combined, these investments represent about 7.5 percent of your total portfolio. That means your overall portfolio is about $70,000.

The low-price fund is categorized as a small-blend fund by Morningstar, while the value-plus fund is classified as a small-growth fund. With the two funds being managed by the same shop, and having some overlap in their investment styles as well as their investment managers, you're bound to have some overlap in their holdings. Are the overlapping investments enough of an issue to sell one of the funds? I don't think so.

When mutual funds share the same investments, you're limiting the diversification benefits of investing across mutual funds. That said, you need to look at your total portfolio and how it's invested, not just these two funds. The stock intersection across all investments will tell you how concentrated your investments are in particular securities.

Deciding on a limit for portfolio concentration can make this an easier decision. If, for example, you decided that no asset in your investment portfolio could represent more than 2 percent of portfolio assets, then it would be easy to determine if your holdings are too concentrated.

It's also not a bad idea to do a holdings-based style analysis on your portfolio. The analysis compares the portfolio's investments to a portfolio benchmark and lets you see whether you are over, under or market-weighted relative to the benchmark. If your holdings mirror the benchmark, then let's hope you're invested in a low-cost index fund, because otherwise it's likely you're paying active management fees for market performance -- also known as closet indexing.

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