Below is a link to a Wall Street Journal article regarding index funds. The article discusses that stocks have become more closely correlated with one another as more money is invested with stock index funds.
The reason for the growth of index funds is clear: 1) very low fees versus an actively-managed mutual fund, 2) ease of replicating an overall index, and 3) lack of consistent performance by mutual fund managers to beat the market.
The author notes that in the past owning just 20 uncorrelated stocks provided the proper diversification, however, today it takes 40 uncorrelated stocks to reach proper diversification. He states that the reason for the increased number of stocks is due to the greater correlation of stocks with one another. In our diversification video available to our members, we present a graph that shows that a holding of 30 to 50 stocks is sufficient for proper diversification.
Finally, the article mentions that proper diversification can also be found with bond index funds and international stock index funds. We totally agree that diversification is the first step to successful investing. Of course, the key question remains – what is the correct asset allocation? In other words, once you have created your diversified investments, or have identified which bond, domestic stock, and international stock index funds to own, you still need to determine what percentage of your assets to hold in each class. That is the $64,000 question!