Consumer Reports: Are Your Investments Too Diversified?

Consumer Reports addresses the hazards of being over-diversification in your portfolio (Are Your Investments Too Diversified?) in an online article that originally appeared in the June issue of Consumer Reports Money Advisor.  They quote Dave on the dangers of loading up on the winners of the recent past, which, while understandably tempting, is like driving with the rear view mirror.

Another common cause of portfolio imbalance is loading up on previous winners. Dave Yeske, managing director of Yeske Buie, a wealth-management firm in San Francisco and Vienna, Va., explains it this way: “People say, ‘I’m looking for the best-ranked funds from Lipper or Morningstar,’ but that will lead them to buy 10 of the same thing. Based on last year’s results, you’d end up with 10 funds investing in U.S. small-cap stocks. The year before, you’d have ended up with a portfolio full of global real estate.”

Another point addressed in the article is the risk of buying mutual funds with seemingly different goals based on their names and stated objectives, only to find that they nonetheless are loading up on the same (often popular) stocks.  Dave points out the virtues of using index funds, which are not only allow you to choose well-defined, non-overlapping segments of the market, but to do so at a tiny fraction of the cost of the average actively-managed fund.

When there’s overlap, many experts advise choosing an index fund. “I don’t know of a stock index that doesn’t consist of hundreds, if not thousands, of stocks,” Yeske said. “That’s one way of being assured of broad diversification within the asset class.” And the operating expenses of an index fund are extremely low. Yeske says that the average charge of all the equity funds in the Morningstar database is about 1.3 percent, about 20 times more expensive than an index tracker. “You just can’t do better than index funds,” he said.

Consumer Reports continues to do a great job of ferreting out the misleading information that is so prevalent in the world of financial services.  You may recall that the Yeske Buie financial planning team participated in a Consumer Reports project aimed at rating the quality of investment plans offered by major firms across the country.