Protect Yourself From a Lopsided 401(k)

Mutual funds offer investors a dizzying array of investments. From broad-range index funds that attempt to track an entire market segment, to smaller segment funds that contain a basket of industry-specific stocks, investors have the ability to truly diversify holdings and spread risk around.

But there’s more to diversification than a mutual fund’s name tag — and those who don’t look deeply enough can find themselves owning several funds that invest in many of the exact same stocks.

Let’s look at some real-world examples of mutual funds offered by popular provider Vanguard where savvy investors might find some overlap.

The following colorful table shows the similarities between Vanguard’s 500 Index (MUTF:VFINX) fund, which tracks the S&P 500, and two other large-cap funds with their own flavors: Dividend Appreciation (MUTF:VDAIX), a dividend growth-focused large-cap fund; and U.S. Value (MUTF:VUVLX), a value-focused large-cap fund.

Dividend Appr.
Weight 500 Index
Weight U.S. Value
4.52% Apple 4.41% Exxon Mobil
4.51% Exxon Mobil
3.23% General Electric 3.42%
PepsiCo 4.22% Microsoft 1.85% Chevron 3.24%
IBM 4.07% IBM 1.82% AT&T 2.75%
Chevron 3.9% General
1.78% Pfizer 2.62%
Exxon Mobil 3.87% AT&T 1.69% Wells Fargo 2.58%
Procter & Gamble 3.72% Chevron 1.68% JPMorgan Chase 2.33%
3.55% Johnson & Johnson 1.5% Cisco 1.67%
McDonald’s 3.47% Wells Fargo 1.44% Procter & Gamble 1.64%
3M 3.27% Coca-Cola 1.42% ConocoPhillips 1.49%
OVERLAP KEY:  Yellow = VDAIX and VFINX       Blue = VUVLX and VFINX       Green = All
Source: Morningstar

Each mutual fund promotes a different investment goal, but many stocks can play several roles. Exxon Mobil (NYSE:XOM), for instance, is a champion dividend payer, qualifies as a “value” stock and belongs in the S&P 500 Index. The result? A lot of overlap.

Let’s look at the top 10 holdings of the S&P 500 fund and the U.S. Value fund. Roughly 18% of VUVLX’s weight is spread across just five stocks — Exxon Mobil, General Electric (NYSE:GE), Chevron (NYSE:CVX), AT&T (NYSE:T) and Wells Fargo (NYSE:WFC). However, those same five stocks also make up roughly 10% of VFINX. Thus, if you owned both of those funds, you’d not only be heavily exposed to a number of stocks (not just those in the top 10, but further down the holdings) … you’d also be paying two sets of expenses for the trouble!

That’s fine if that’s what you want — you could do worse than piling into solid companies like Exxon and Procter & Gamble (NYSE:PG) — but if your ultimate goal is diversity across your funds, that’s a redundancy you can’t ignore.

This issue isn’t limited to the mutual fund world, either. A number of exchange-traded funds — which you can buy in individual brokerage accounts — suffer similar problems.

One of the biggest targets of overweighting is Apple (NASDAQ:AAPL). For instance, the PowerShares QQQ Trust (NASDAQ:QQQ) — an ETF that tracks the Nasdaq-100 index featuring the Nasdaq’s biggest stocks — is weighted nearly 20% in Apple stock. The Technology Select Sector SPDR (NYSE:XLK), a tech-specific fund, has a roughly 19% weight in AAPL.

Not only would buying both funds severely overweight you in Apple, but considering the glut of mega-cap tech stocks in the Nasdaq-100, you’d be overweight in a number of big technology names, including Microsoft (NASDAQ:MSFT) and Google (NASDAQ:GOOG).

One way to avoid this kind of overlap is buy targeting funds that invest in different-sized stocks or in varying geographic areas, or seek out different asset classes altogether.

To keep with the Vanguard theme, rather than loading up in various U.S. large-cap equity mutual funds, spread the wealth across funds like Mid-Cap Growth (MUTF:VMGRX) and Small-Cap Growth (MUTF:VISGX), which, as their names suggest, respectively target mid- and small-sized companies with growth opportunities. Funds like Emerging Markets Select (MUTF:VMMSX) will get you exposure to equities in emerging markets like China, Brazil and South Korea, while Vanguard Long-Term Treasury (MUTF:VUSTX) will expose you to Treasury notes, further diversifying your portfolio and providing steady income.

Of course, there’s a world of other mutual fund providers out there — heck, Vanguard funds might not even be offered in your 401k plan — so research any options you have available.

Bottom line: If you haven’t in a while (or ever), get to know your funds. You can find out much of what you need to know from from mutual fund providers’ websites, though investor information sites like Morningstar also are useful. Read the prospectuses, go through holdings, get an idea of how your funds invest their assets.

You’ll be all the wiser for it — and so will your investment choices.

Marc Bastow is an Assistant Editor at As of this writing, he was long XOM, AAPL and MSFT.

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