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Investing for The Wealthy

Reduce Overlapping

02/14/2019

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If you are a novice investor, you may or may not be familiar with the term “overlapping,” or understand why you as an investor would want to reduce overlapping at every opportunity.
This article will discuss strategies to reduce overlapping, and aims to educate investors on some strategies for better diversification of their respective portfolios. Read on to learn more.

What is Overlapping?

Fund overlapping occurs when an investor owns multiple mutual funds with similar objectives and weighting. This leads to a situation where many similar securities or equities are held by the same investor.

This has the opposite effect of diversification, as an investor unwittingly exposes her or himself to additional market risk by potentially overinvesting in a given stock or sector.

Why is Overlapping a Potential Problem?

As noted above, overlapping is the antithesis of diversification, and it exposes an investor to unneeded market risk.

If a given equity or market declines, an investor can potentially (and needlessly) feel double the pain, as some of the assets within their portfolio share too many characteristics and decline simultaneously.

So, it’s important to reduce overlapping whenever possible, and to ensure you don’t place too many eggs into the same financial basket.

Tactics to Reduce Overlapping

Below are a few of the more conventional tactics for reducing overlapping, as many seasoned investors have learned how to limit self-inflicted financial wounds by keeping their portfolios as diverse and robust as possible.

It behooves most any novice investor to consider some of these strategies, in the interest of reducing overlapping:

Diversify Markets and Sectors

Investors may tend to gravitate toward sectors that they understand, or that have yielded great returns in the past. It’s human nature to go back to what has worked for us previously.

An investor may have, for instance, a comfort and familiarity with healthcare, or may feel – perhaps rightly – that healthcare-related investments present the greatest opportunity for growth in the near future.

This does not make the investor or investment manager wrong, but it can cause overlap. And it may take some willpower, but wading into new markets and sectors is a good way to limit overlap.

There are currently eleven sectors of the stock market, each with unique advantages and disadvantages. Investors and potential investors should educate themselves a bit on the respective quirks of each market, and consider additional or alternate investments as a diversification tactic.

Even if an investor has made a fortune in energy, it remains a smart practice to diversify as much as possible in the interest of hedging against losses and opening up oneself to potential high-yield markets or equities.

Another approach would be to get those who tend to overinvest in stocks to consider index funds as an alternative investment. Index funds can greatly broaden a portfolio, while also limiting some of the riskiness inherent to stock investment.

Don’t Purchase Multiple Funds from the Same Manager

Portfolio or money managers are apt to use the same stocks over and over again, particularly if they’ve had success with a certain equity in the past. This, of course, can cause significant overlap.

This rule isn’t set in stone, as you may have an excellent investment manager who is wise enough to reduce overlapping and be proactive in protecting your financial interests.

But diversification is Investment 101, and this applies doubly to managers. If you choose not to manage your own investments, it’s probably in your best interest to consider using multiple investment managers in order to reduce overlapping.

Guard Against Funds with Shared Objectives

A common-sense approach to limiting overlap is to simply keep one fund within each fund category.

For example, restricting your investing to one small-cap, one large-cap, and one mid-cap stock fund is a good way to improve your potential yield while safeguarding against the problems associated with smaller-cap stocks.

Another way to divide stock fund categories would be to divide the funds by objective rather than market cap. As another example, an investor could choose to focus on a single growth stock fund – one which is expected to develop at an above-average rate – while also selecting a value stock fund or dividend mutual fund that the investor or manager believes is currently moving below market value.

Lastly, an investor or manager could prevent overlap by better diversifying bond investment. Bonds can first be categorized by duration, with very short-term bonds having durations of a year or less while longer-term bonds have durations of ten years or more.

Possible Bond Options

There are, of course, a number of bond fund options with maturation terms in between those two timeframes, and an investor guarding against overlap could better diversify by investing in a few mid-length bond funds.

Bonds are also broken down by the issuer. Government or U.S. Treasury bonds are perhaps the most well-known type of bond, but there are also bonds issued by corporations as well as local municipalities.

U.S. Treasury bonds pay out interest in six-month intervals, and fully mature after 30 years. Meanwhile, municipal bonds tend to have much shorter durations (often 6-10 years). Diversifying your bond investment by both duration and issuer are two other good ways to minimize overlapping.

The more ways that you as an investor can diversify, the more you can minimize overlapping. Carefully assessing the objectives of each stock or bond fund, and restricting yourself to a single investment within each category, is another strong way to diversify your investment dollars and guard against overlap.

Reduce Overlapping and Improve Returns

We all know there can be too much of a good thing, and assets that overlap too much can be evidence of that.

While overinvestment in a given category, market, or sector can be very lucrative for a time, inevitably overinvestment and overlapping can lead to staggering, unnecessary financial losses.  Investors can best protect themselves by reducing overlapping and diversifying their investment dollars in as many ways as possible.

While no one should invest for the sheer sake of novelty, making smart, targeted investments within different or emergent markets is a solid strategy for prolonged financial success.

Linden Thomas & Company

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