Mutual Funds

Question 23 • 26-27 Ignite Financial Literacy Personal Finance - EL3403

Why is too much diversification considered a negative thing when dealing in a mutual funds?

Answer

Higher diversification means that the mutual fund costs a lot more and doesn’t provide as much profit.

When there is too much diversification in a mutual fund, great success in a single stock doesn’t make much of a difference in the overall progress of the fund.

If there are too many different investments, it would be too hard to keep track of them and some would inevitably get lost in the system.

Greater diversification means a drastic increase in taxes, so most companies avoid overly diversifying the mutual fund.

Explanation

With too many investments, each individual holding makes up a smaller share of the mutual fund. As a result, even a stock that performs exceptionally well has only a limited effect on the fund’s overall performance. This matches choice b.

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