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Diversifying: 5% only rule
Old 01-16-2008, 11:56 AM   #1
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Diversifying: 5% only rule

Does the majority feel that you should put 5% only of your total investment monies in one account? In other words, if you have $100,000 to invest then you should take that $100,000 and break it up into 20 separate stocks/mutual funds or whatever, which equals investing $5,000 in each one. That means 20 separate investments to track.
Good advice?
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Old 01-16-2008, 12:04 PM   #2
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Does the majority feel that you should put 5% only of your total investment monies in one account?
I'm comfortable with putting $100k into one account. Then, diversify the $100k into various investments, per your AA, within that account.
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In other words, if you have $100,000 to invest then you should take that $100,000 and break it up into 20 separate stocks/mutual funds or whatever, which equals investing $5,000 in each one. That means 20 separate investments to track.
A single mutual fund, depending on which one, may be adequately diversified. A single stock, no.

Applying the 5% rule of thumb to accounts, mutual funds and stocks is inappropriate. I'd only apply that rule to stocks and focused mutual funds.
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Old 01-16-2008, 12:08 PM   #3
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I don't agree with it.

For one thing, a broad fund like VG total stock market index is plenty diversified. You don't really need any other US stock fund, although I have others. I am between 15-20% in that fund though.

And I think I remember someone like Peter Lynch suggesting against too many stocks. Pick between 8-12 (I really don't remember the suggested number) that you can really follow. If you have too many, there's a reasonable chance you haven't spent enough time researching some of them. Of course, some people spend more time and can do this.
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Old 01-16-2008, 12:20 PM   #4
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And I think I remember someone like Peter Lynch suggesting against too many stocks. Pick between 8-12 (I really don't remember the suggested number) that you can really follow. If you have too many, there's a reasonable chance you haven't spent enough time researching some of them. Of course, some people spend more time and can do this.
Actually, the 5% rule of thumb is congruent with Lynch's position.

Say you're in a 60/40 $100k portfolio. You have $40k in fixed investments. You have, say, $30k, in equity MF's. You have $30k remaining you like to invest in individual stocks. Given Lynch's guideline of 8 - 12 stocks (let's say 10), and the 5% rule of thumb, that would mean put between $3k and $5k in each stock. That would give you no more than 5% in any one stock and no more than 10 total stocks.

There both just guidelines......rules of thumb...... But they seem reasonable to me. Especially compared to breaking the "all your eggs in one basket" rule!

I think the important think for Orchidflower to get clarified on is the difference between "account," "mutual fund" and "stock." Little need to diversify between accounts. Some need to diversify between mutual funds. Much need to diversify between stocks.
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Old 01-16-2008, 01:42 PM   #5
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I think the 4 or 5% rule is a very good guideline, but it should only apply to stocks. I violate the rule with Berkshire because it so diversified (almost a mutual fund), I think the same thing would apply to GE.

Because of previous employment Intel was 9% of my portfolio, with the stock down 13% today it is now 8% of my portfolio. Trust me this isn't the ideal way of reducing a concentrated stock position.
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Old 01-16-2008, 01:53 PM   #6
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Hey Orchidflower,

Quote:
break it up into 20 separate stocks/mutual funds or whatever, which equals investing $5,000 in each one.
I would think that this asset allocation would tend to be inefficient and unwieldy to manage. With Vanguard, you would probably never be able to capture any Admiral class advantages.
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Old 01-16-2008, 02:02 PM   #7
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Orchidflower, I'm strictly a mutual fund investor, so that seems way too restrictive to me. I'd be comfortable with all my retirement savings in a single target retirement fund.

You would get lots of mail, though

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Old 01-16-2008, 02:17 PM   #8
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I think that the 5% idea comes from active trading theory where the idea is that you take lots of small bets but never risk more than 5% on any one bet.

As most here have said, we tend to focus on diversifying by having mutual funds that are split according to an appropriate asset allocation strategy.

For example, some percent in bond funds and some percent in stock funds. Within bonds some in government, some in corporate, some maybe in foreign government. Within stocks, some in US, some in foreign, smaller amount in emerging markets, some split between growth and value or large cap and small cap.

Here you would figure out the appropriate percentages by reading a book like The Four Pillars of Investing. 5% in each would not be correct, but the exact split depends on your individual situation.

If you would like to read more about active trading with a bent toward gambling and gaming theory you can read Trade Your Way to Financial Freedom by Van Tharp. He covers the math associated with this strategy pretty well. Keep in mind that this is a totally different mind set from the long term investment methods.
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Old 01-16-2008, 03:03 PM   #9
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That's about what I did with stocks, and it was enough to keep the losers (WorldCom was one of mine) from killing you while letting the winners have a significant effect. And that's plenty of stocks to keep tabs on.

I'm using 5% to 10% for each asset class in my slice-and-dice mutual fund portfolio. I tend to have two different funds when I go to 10%, but not always. I probably have 30 funds now, between the 15 asset classes and nine different accounts. Two 401k's kind of bloats the fund count. I hope to reduce the number of funds as I get the chance to rollover the 401k's and consolidate where I can, but it's not bad for now.

Maybe 20 stocks wasn't so bad!

Before anyone asks, here are the asset classes I'm using:
Energy/natural resources
Emerging Markets
Foreign large-cap growth
Foreign large-cap value
Foreign small-cap
Foreign real estate
Domestic real estate
Domestic large-cap value
Domestic large-cap growth
(with separate diversified, health, defense, and financial sub-classes)
Small-cap growth
Small-cap value
Cash
(plus some temporary bear market holdings for this year.)

Dan
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Old 01-16-2008, 03:11 PM   #10
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I have 43% of my assets in one mutual fund, with no other fund more than 10%, and no asset class more than 15%.

PRFDX is where my core retirement monies are sitting (growing?).
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Old 01-16-2008, 08:27 PM   #11
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Interesting variety of answers. I'm a mutual fund person, and probably will remain so. But the thought of juggling 20 mutual fund accounts seemed a little much. I really wonder if it would be worth it ultimately?
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Old 01-16-2008, 08:53 PM   #12
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As written, there is no 5%-only rule with mutual funds. And it ain't worth divvying up one's assets into 5% or less chunks. That said, we have something like 40 mutual funds/ETFs/stocks in about 16 accounts. There is no juggling involved because most of them are on auto-pilot like the 401(k)s, the 403(b), the 529 plans, the inherited IRA, etc.

Now what about the rule of not having any account or fund with less than 5% of your assets. That is, that pipsqueak IRA with just 0.5% of your total assets is kinda lame.
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Old 01-17-2008, 02:34 AM   #13
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Yes, diversify stocks... the allocations may not be 5% per stock...

Mutual funds do some diversification. However, even funds require some diversification across different asset classes and across international boundaries.


I am assuming that you were referring to assets and asset classes not splitting your money across several mutual fund companies or brokerages just in case they do something wrong (fraud, etc...) or some blunder that was out of the ordinary that causes you to lose money.

Personally, I have a little concern about keeping all eggs in one MF company basket. You never can tell when someone will compromise everything (in Corporate Management). Does anyone else have this concern? Or do you think it is nothing to worry about?


Right now, our money is split across 3 organizations. If we rollover any 401k, etc.... I cam considering putting half at some other low cost organization. Perhaps T. Rowe Price.
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Old 01-17-2008, 07:09 AM   #14
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We have something like 40 mutual funds/ETFs/stocks in about 16 accounts. There is no juggling involved because most of them are on auto-pilot like the 401(k)s, the 403(b), the 529 plans, the inherited IRA, etc.
Wow. Isn't there any way to consolidate those accounts (and simplify your financial life)?
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Old 01-17-2008, 08:39 AM   #15
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Putting all the money into one company like Vanguard is no real concern to me, but all the money into one mutual fund is a no way. Am I wrong people? I am here to learn and listen (or read as is the case here).
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Old 01-17-2008, 08:52 AM   #16
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Putting all the money into one company like Vanguard is no real concern to me, but all the money into one mutual fund is a no way. Am I wrong people?
I agree with youbet:

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A single mutual fund, depending on which one, may be adequately diversified. A single stock, no.
If you can find a fund with an asset allocation that meets your liking, such as one of the Vanguard Target Retirement funds, there is no reason to go with more than one. Costs (fund expense ratios) should play a role as well.

Human nature being what it is, many of us choose to go with more than one fund in the uncertain hope of hedging our bets. To my way of thinking, more than 6 or so is probably overkill.
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Old 01-17-2008, 09:14 AM   #17
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Hmmm - very roughly with a few transgressions over the years(theoretical impurity):

85% Target Retirement 2015 (first ten years of ER big dog was Lifestrategy moderate with small amounts of REIT, Sm Cap value indices).

15% individual stocks where I dollar cost averaged in 2 -3% over 7 -10 yrs in DRIP plans - let the chips fall where they may NEVER rebalancing - sold the dogs, mergers and spin offs I didn't like. Diversification was a very crude - try to spread among industry groups - BUT at various times I overbought areas getting creamed - in the 90's for instance banks with bad South American debt, Hillary's big pharma, utilities especially water when I had a brain phart, nuclear utes when they were unloved, etc.

So I pay lip service to diversification but don't get too anal(unusual for me) - still hope one stock will take off and put me in the villa in the Bahamas with that cheeseburger in paradise.

heh heh heh - snow on the ground in Kansas City - just had a couple of kids at door with snow shovels hustling the neighborhood - good for them.
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Old 01-17-2008, 09:29 AM   #18
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heh heh heh - snow on the ground in Kansas City - just had a couple of kids at door with snow shovels hustling the neighborhood - good for them.
Adjusting to the white stuff? heh heh heh
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Old 01-17-2008, 09:44 AM   #19
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Adjusting to the white stuff? heh heh heh
Yep. A tad different than last Sunday - the Steven E. Ambrose memorial Parkway headed to Bay St Louis to watch football and pop in the Hollywood Casino.

Need to take out my pickup later - with the one snow tire and tube sand in the back - for a test run.

Maybe diversification wise - I will invest in a few more snow tires before spring.

heh heh heh - the flip side, I've read several times over the years - you should always invest at least 5% to have a big enough stake to effect your portfolio - another rule I violated.
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Old 01-17-2008, 09:50 AM   #20
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85% Target Retirement 2015 (first ten years of ER big dog was Lifestrategy moderate with small amounts of REIT, Sm Cap value indices).

15% individual stocks where I dollar cost averaged in 2 -3% over 7 -10 yrs in DRIP plans ....
I thought I heard a pssst coming on... What's up with that?
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