If You Own Everything, You Actually Own Nothing
by Hodges Private Client Team, on Jun 2, 2021
What constitutes overdiversified investment portfolio?
How familiar does this scenario sound to you? Into your personal account, IRA, or 401k you pick a couple of the best performing mutual funds you can find. You spread around your contributions into each one. Then, at the start of the next year, you again look for the best funds and make another contribution. Year after year, repeat, repeat. Perhaps your employer changed 401k providers, and you had to choose from a whole new set of funds. At the end of a couple decades, you might end up owning 10-20 mutual funds in the aggregate of all your accounts.
Certainly, there is nothing wrong with owning mutual funds. They are great investment vehicles when you have smaller sums of money and are in the accumulation phase of your investment life, but if you own too many, you might have gaps or redundancies in your investment portfolio. There might be a better way to have larger sums of money managed. Allow me to explain.
In the above example, there was no philosophy nor strategy in choosing those funds. You were probably given a narrow list of funds from which to choose, and so you did a little homework, and made a selection. For most folks, this is merely an exercise in picking the best performers (from past data, mind you), and crossing your fingers. If we dig a little deeper, we might find that the average mutual fund (depending on size) might contain 100 stocks. Multiply that by 10-20 and you’re the proud owner of fractional bits of 1,000-2,000 stocks! On top of the sheer volume of stocks you own, many funds own the same stocks. In some instances, you could theoretically own the stock of XYZ 10, maybe even 15 times.
Let’s go another layer deep and talk about transparency and fees. One day you want to see what stocks one of your funds owns, so you visit the mutual fund company’s website, and filter through all the tabs and drop downs, and alas you find the fund data. You will be able to find a list of all the stocks they owned as of the prior quarter’s end (March 31, June 30, Sept 30, Dec 31). If you are lucky, they’ll show you the top 10-15 stocks they hold currently. You will never be able to pick up the phone and talk with the fund manager about his/her thoughts on the market, certain industries, or stocks. On the fee front, mutual funds have various annual fees that fund their operating expenses, paying the managers, and keeping the lights on, etc. These can be anywhere between .25%-1.5% depending on the size of the fund, the types of stocks they purchase, or investment style they follow. The fees come out of your investment dollars. If you then have an advisor handling your affairs this way, do not forget to add on their management fee as well. Again, these vary depending on the scope of what your advisor provides, but for most accounts around $1mil, it’s safe to budget around 1%.
Finally, let’s touch on tax inefficiency. Once you’ve made your contribution from your taxable investment account into a fund, your money has now gone into a pool with hundreds or thousands of other people. The fund manager invests the money, but you have no ability to influence the manager as to when to harvest gains or take losses. You could be hit with an unwanted 1099 at the end of the year.
So, let’s bring this all home. If you are invested this way, you most likely have redundancies in holdings that are entirely unnecessary, you have no day-to-day look into what you actually own, tax gains/losses are uncontrollable, and you’ve paid twice (once to the funds and once to your advisor). If you spread yourself too thin, you might compromise your results.
If this sounds like your current portfolio, we believe there is a more efficient way to provide ample diversification, true transparency, and tax efficiency. We would enjoy talking with you.
Wide diversification is only required when investors do not understand what they’re doing. -Warren Buffett
Hodges Capital Management, Inc. is a Federally Registered Investment Advisory Firm registered with the SEC. The above discussion is not intended to be a forecast of future events, a guarantee of future results, and should not be considered a recommendation to buy or sell any security. Past performance is not indicative of future results. Investing involves risk. Principal loss is possible. Investing in smaller companies involves additional risks such as limited liquidity and greater volatility. No current or prospective client should assume that information referenced in this communication is a recommendation to buy or sell any security. Different types of investments involve varying degrees of risk. No client or prospective client should assume that any information provided is a substitute for personalized individual advice from the adviser or any other investment professional. This document was created for informational purposes only and the opinions expressed are solely those of Hodges Capital Management, Inc.