If you are investing $10,000 or less, choose just one fund in each of the asset allocation categories. If you are investing more than that, you may choose an additional fund or two in each category, though it really isn’t necessary. It is not important to hold a number of different funds in each category, as it would be if you were holding individual stocks.

Investing in two funds that are similar will not diminish risk. It’s true that diversification among types of funds decreases risk, but this is true only if the portfolio has diverse components, and investing in two funds of similar type does not produce this diversity.

The SmartMoney site is a good source for information on the performance of particular funds. I also like Morningstar.com, one of the most respected reporting services on mutual funds. They have loads of information on every fund, and allow you to x-ray your funds to see where the overlaps are.

Sticking to your guns

Some investors buy the hot performers each year, but never sell any of their prior fund investments. After several years, they have a complicated mishmash of overlapping funds that are difficult to monitor. Some are performing well, and some enjoyed only a brief time in the spotlight before they faded. These investors own funds just as some people eat berries: they begin by choosing only the best in the box, but they end up eating everything.

To keep this from happening to you, here are some rules to follow:

• Stock to your asset allocation. If you find a new fund you want to buy, make sure it fits your portfolio’s objectives.
  
  
• Limit the number of funds you own. That way, you will be forced to week out the poor performers before you invest in a new fund.
  
  
• Don’t let your investments overwhelm you. If you find you own more funds than you can handle, combine your investments in similar funds until you have weeded your investment garden to a manageable few funds.

Investing with one mutual fund family or brokerage

Consider keeping your money all in the family – or at least in a family or two. You don’t need to worry that your funds won’t be diversified within a single family.

The twenty largest fund families offer a combined total of over one thousand different mutual funds. Large no-load and low-load families include Dreyfus, Fidelity, Gabelli, Janus, T. Rowe Price, Scudder, American Twentieth Century and Vanguard.

When choosing a family of funds, concentrate on selection, performance and service, not the safety of your money. Even if the funds’ sponsor has financial difficulty, your money won’t disappear, because the fund assets are insulated from claims of the sponsor’s creditors. Nor can the fund manager run off with your money: all officers with access to money are covered by fidelity bond coverage. And the Securities Investor Protection Corporation (SIPC), which is much like the FDIC for banks, guarantees that your mutual fund shares will be safe even if a brokerage firm holding them for you goes bankrupt.

There are many advantages for investing in a single family of funds. Your transaction statements will be in a consistent format, and some funds even combine your funds onto a singly account statement. You will be able to switch money from fund to fund with ease as your investment needs change. And if you are investing in funds that charge a load, the loan may be reduced if you invest a certain amount within the same family of funds.

If you want to invest in funds in several different families, consider using a mutual fund supermarket or brokerage such as Schwab, TD Waterhouse or Fidelity USA to do so. You can purchase a variety funds through these companies at little or no cost.

If you want the simplicity of investing in just one mutual fund, you might want to try an asset allocation fund that invests your money in a variety of different assets within the same fund.

Examples of such funds are Vanguard Asset Allocation and Fidelity Asset Manager. You may also consider target funds, such as the Fidelity Freedom series, which target particular dates.

For example, Fidelity Freedom 2010 assumes you’ll need to withdraw your money in the year 2010, and so the manager will be more conservative in the investments he makes as that date approaches. These funds would be ideal for investing for a child’s education, where the money will be needed when the child enters college.