It's the one mantra on Wall Street that almost everyone subscribes to.
But how diversified are you really?
If you don't pay attention, you could fall into an overlap trap.
For example, consider these high-flying funds: Alger Capital Appreciation B, Fidelity Select Technology, and Rydex OTC. Each produced annualized returns of 38 percent or better over the past five years, putting them among the top 10 funds for that time period.
And they sound diversified.
But investors who poured all their money into these three funds could be making a dangerous mistake. All three invest heavily in volatile technology stocks. In fact, they invest in many of the same stocks.
To avoid overlap in your portfolio, investment experts suggest you take a good look at the funds you own. Make sure they don't all invest in the same sectors of the economy, use the same strategy (say, growth instead of value investing), or buy the same-size companies (say, large-cap instead of small-cap).
If you're being especially diligent, compare the top 10 holdings of each of the mutual funds you own. There's bound to be some overlap. If there's too much, jettison lookalikes.
"Every investor needs to look carefully at their portfolios," says Amy Granzin, domestic equity analyst for Morningstar Inc. "You want to allocate your assets.... If you have an S&P 500 index or large-blend fund, diversify into a small growth or small-cap fund."
A software solution
One of the spiffiest tools to spot diversification problems is a software program called Overlap. Investors can use it to compare more than 3,000 mutual funds. It detects which stocks various funds have in common. It also finds which sectors funds concentrate on.
"It's possible to have a zero percent overlap in two funds on a stock-per-stock basis, but you still may be heavy in [particular] sectors," says Richard Berg, an assistant to Overlap Inc., based in Kansas City, Mo.
The program doesn't come cheap. A year's subscription, which includes four quarterly CD-ROM disks, costs $158. But the tools are so easy to use and comprehensive, the program may make sense for the active investor with tens of thousands of dollars at stake.