Does one reduce risk by investing in mutual funds held by different groups?

February 9, 2009 8:57 AM

Does one reduce risk by investing in mutual funds held by different groups? If I invest in an S&P 500 index fund with both Fidelity and Vanguard is that better than just going with Vanguard? Or is the SIPC protection such that I need not worry about such things?

Many responders to this question seemed to indicate having your accounts all in one place would be a good idea because it eases management. That is definitely attractive.

posted by grouse to work & money (7 comments total)

There is no sure-fire answer to this. You have to do your homework and see what your investment portfolios contain. Further, do research on your fund manager to see his or her risk management patterns. I only invest my funds directly, so I cannot comment as to the efficacy and style of either company, but you have to dig deeper if you aren't content with letting them take care of everything. However, to speak in generalities, some offer their managers more flexibility, others are more strict about their leeway. It's hard to form a good repoire unless you're shelling serious dough out, but due dilligence is always the answer.

Best,
posted by stratastar at 9:16 AM on February 9

From a board filled with risk-averse Vanguard investors: Is there a reason NOT to keep all assets at one Fund Family?
posted by smackfu at 9:23 AM on February 9

An argument against spreading things around would be that many firms offer reduced fees for assets over a certain level, like $100k or $500k. Depending on the size of your pile this may or may not be a concern. You'll need to do a bit of risk/reward calculation to account for that.
posted by charlesv at 9:35 AM on February 9

This is not my area of expertise, but I think it's probably extra hassle for not much benefit. I say this for two reasons:

1. Firms like Fidelity and Vanguard generally do not have highly-leveraged balance sheets that could cause them to fail dramatically. Firms like Bear Stearns and Lehman Brothers were engaged in market-making, securities underwriting and proprietary trading for their own account. Those are the type of activities that require a firm to puts its own capital at risk. Pure asset managers do not generally do this sort of thing.

2. While it's sensible for you to want to diversify your counter-parties, if you do this you are probably needlessly replicating what these firms are already doing themselves. Because of all the madness surrounding the Bear/Lehman failures, every serious investment firm has conducted a massive review of its counter-party and prime brokerage relationships. Firms the size of Fidelity and Vanguard probably spread their business to every single solvent counter-party out there--big custodial players like State Street, Bank of NY Mellon, Northern Trust; market makers/prime brokers like Deutsche Bank, UBS, Goldman, JPMorgan, Merrill, etc etc. If you split your money 50/50 between Fidelity and Vanguard, it may seem like you have spread out your counter-party risk, but in reality you're just connecting to the same wide and complicated web of relationships from two different (and very similar) starting points.
posted by mullacc at 10:12 AM on February 9 [2 favorites]

My answer above assumes the risk you're worried about is the failure or technical incompetence of your financial intermediary. If you're interested in actively managed mutual funds and the risk you're worried about relates to the investment judgment of your financial intermediary, that's another story.
posted by mullacc at 10:20 AM on February 9

SIPC insurance limits are 500k in assets per customer per brokerage, so for most people it's probably not necessary to diversify in this way.
posted by phoenixy at 12:10 PM on February 9

Issues I see:

1- For index funds, probably no reason to do it. If one fund mirrors the S&P, the other will too. Probably the only difference will be how well the managers react to changes in the component stocks. It might be a fun experiment to split equally and see what the difference is after 5 years, but I see no value in it.

2- For other types of funds, I would look carefully at what the component stocks are. You could possibly accidentally over-diversify to the point that you are accidentally overexposed to one sector or another. If you invest equally in the CompanyA SteadyGrowthFund and in the CompanyB TortiseFund, what if they both hold GM stock? Instead of spreading risk, you have concentrated it, and paid for the privilege.
posted by gjc at 5:16 PM on February 9