What about mutual funds--how many mutual funds do you need to have a diverse enough portfolio? To find out if more funds mute volatility the same way more stocks do, Morningstar created hypothetical portfolios ranging from one to 30 funds, using every possible permutation of funds. We then calculated five-year standard deviations for each of those portfolios. Higher standard deviation can spell bigger gains or losses, while a lower number indicates a less volatile portfolio.
Morningstar found that single-fund portfolios had the highest standard deviation, delivering either the biggest gains or the heaviest losses. So owning just one fund can be a risky bet. Add a fund and the standard deviation drops significantly. Returns are lower, but the downside is less severe, too.
After seven funds, however, a portfolio's standard deviation stays pretty much the same regardless of how many funds you add. In other words, once you own seven funds, there may be no need for more.
Of course, the same caveats that apply to studies of how many stocks you need apply here, too.
What You Really Need: Diversification >>