Mutual funds usually shun the “eggs-in-one basket” approach of investing by placing clients’ money into different kinds of assets. Investors, ranging from pension fund administrators to private investors, choose diversified portfolios because they recognize that economic conditions, government regulations, and national and world events affect companies, industries, and assets such as stocks and bonds differently. You might buck this approach, opting for non-diversified funds, which can reap higher returns if the stocks are picked correctly.
Diversified funds cast a wide net for assets, catching bonds, cash, and stocks from many companies. Under federal law, a fund cannot tie more than 5 percent of its value in a single company's stock. Non-diversified funds concentrate their efforts in a single industry or geographic sector. You may find bank stocks in a bank-sector fund or in a financial-sector fund, along with insurance companies, real estate interests, and brokerage houses. An energy-sector fund might consist of power companies and oil and gas refineries and distributors. If you go the telecommunications route, your fund will have land-line phone, wireless communications, and internet providers. Some funds invest in stocks from particular countries or continents.
Non-diversified funds often rise and fall with events and economic conditions because those factors similarly affect most businesses in the sector. With more risk comes the possibility of substantial gains if the sector does well. An event or condition can benefit one sector of funds and hurt another. For example, high oil prices help energy-sector funds, but could hit funds based on consumer stores and manufacturing because of increased transportation and production costs. If you opt for diversification, you can absorb hits in some assets with gains in others. You are also more likely to stay in for the long-haul even when the market descends; as the market rises with time, so will the value of your investment.
Sector funds rely on fund managers with expertise in the particular industry or country to achieve greater performance with less risk. The manager concentrates on companies or places represented in the sector, rather than examining a broad array of assets and companies. In a diversified fund, the manager relies less on timing upticks in the market or an industry and more on the right mix of assets to lessen the impact of downturns.
If you seek the relative safety of a diverse portfolio, the diversified mutual fund path can be cost-efficient and time-efficient. The person controlling the fund has already decided what he believes is the best mix of products. You have one fee or set of fees, which are spread across many assets. If you try to diversify using individual sector funds or even individual stocks and bonds, you must research and pick the ingredients for your portfolio yourself.
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- American Bar Association Section of Business Law: Report of the Task Force on Investment Company Use of Derivatives and Leverage
- University of Pennsylvania Wharton School of Business: Missing the Big Gains: Foreign-Stock Funds and the Benefits of International Diversification
- Investment Company Institute: 2006 Investment Company Factbook: Appendix A: How Mutual Funds and Investment Companies Operate
- Financial Industry Regulatory Authority, Inc.: Building Your Portfolio: Using Diversification
- Brigham Young University: Marriott School: Personal Finance: Disadvantages of Mutual Funds
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