The other day I was thinking about how these days, everyone recommends a certain fund to invest in or a particular group of funds. There are ETFs and Index fund recommendations everywhere. What the heck is in Vanguard’s “Wellington Fund” anyway? What about international funds? Or biotechnology? I thought it might be good to take a peek inside my own family’s retirement account allocation in order to better understand what we’re actually invested in.
The growth of the mutual fund industry and now the index fund and ETF industry have done a lot of good for investor – no doubt. There’s a lot more built in diversification than there used to be. However, fund names often blur the lines and act as a psychological barrier between what an investor thinks she and owns and what she actually owns.
Also, even with investors like me who invest strictly in just a couple funds in retirement accounts, say an S&P 500 index, methodologies are changing all the time. The S&P 500 now allows for things like mortgage REITS (mREITS) which would never have been allowed in days past.
You’ve got to look at turnover too. The people you’ve entrusted to manage your retirement money through your 401(k) at work or your IRA often change out different securities within the funds you hold. Companies and grow and companies shrink, so relative weightings change over time as well.
All this is to say; you should know what you’re investing in. It’s such a simple thing to check up on but a lot of people don’t take the time to do it nonetheless. Simply taking a fund description’s word at “heavily diversified index” is a good start, but it’s not exactly due diligence. Take a look at the prospectus for each fund you invest in. I decided to take the time and check out my own family’s allocation, and it looks something like this:
You’ll notice the biggest position is in company stock. I know a fair amount about how my company makes money, what a lot of the risks are, and what past performance has been like, so I feel comfortable with this being the largest position here.
From there on you’ll see the usual suspects: Apple, ExxonMobil, Google, Chevron, Wal-Mart, Microsoft, etc. These are the big American companies that everyone knows about. Given diversity across industries and the relatively small piece of the pie that they each make up here, I’m cool with that.
I remember when I first looked at an S&P 500 prospectus and looked over the top holdings. Apple is over 3% even though it’s just one of the 500 components?! Yep. If there’s a huge change in technology and iPhones become irrelevant tomorrow, the impact to my portfolio is going to be greater than say, if Facebook went under (1% shown above).
This is just one example. Every stock mutual fund and stock index fund is made up of hundreds of components of individual stocks. Every bond fund is made up of bonds. Most “balanced” funds tend to be made up of a combination of both.
The financial media over at least the past decade or so has really pushed investments in mutual funds, index funds, and ETFs. When people say “never ever buy individual stocks, they’re too risky!” and then go ahead and buy stock mutual funds, I just shake my head. Sure, there’s a lot of diversification from owning index funds. I own index funds. But for an investor who has sizable assets it could make sense to invest in a collection of individual securities, but that’s already been explained by somebody else.
The problem is, people don’t know what they own. At the very least, take a quick look at the top 10 holdings in each of your funds. Did anything surprise you? Are you comfortable with how your managers are allocating your funds? Don’t be shy about seeking fundamental information about what you actually own – behind all the fund names.