Many people mistakenly assume that in order to invest successfully, you need have a wide variety of investments. While a diversified portfolio is indeed an important element of balancing return potential with risk management and safety, being diversified doesn't necessarily mean owning a huge number of different investments. To make it easier for investors to hold well-rounded portfolios, mutual fund companies have established core funds that can be used as the foundation of your investment strategy. Let's look at core funds and whether you should include them in your portfolio.

What are core funds?

Core funds are designed to constitute the essential elements of your overall investment portfolio. Different fund companies define core funds differently, but typically these funds include several types of investments that are suitable for most investors, making it easier to get the investment exposure they want without buying a huge number of individual stocks, funds, or other securities.

The primary purpose of core funds is to provide a stable base that doesn't require much, if any, adjustment over long periods of time. Although people might invest a small portion of their overall portfolios in noncore opportunities in an effort to boost overall returns, keeping their core funds intact ensures they can reliably stick to their investment strategy and simplifies the handling of additional investments.

What is the history of core funds?

The idea of having a primary fund-based holding in your portfolio has been around for decades, with many investors employing the strategy of having a broad-based mutual fund as a core holding while adding individual stocks to boost overall returns. The rise of index mutual funds dramatically increased the use of the core fund concept, as index funds tracking broad-based indexes such as the S&P 500 made excellent core funds for most investors seeking to match the return of the broader stock market.

Nowadays, fund managers market a wider variety of their offerings for potential use as core funds. Morningstar points to large-cap blend and large-cap value funds as good core fund holdings, as they offer solid but unextraordinary returns with less volatility than more aggressive stock mutual funds. Similarly, on the fixed-income side, core funds often combine Treasury, corporate, and municipal bonds to provide balanced exposure to the bond market. As international investing has become more popular, global core funds have emerged that aim to balance their investments in developed and emerging-market nations around the world.

How many core funds are there?

Any mutual fund can be used as a core fund if it aligns with the goals of a particular investor. What many investors consider a specialty fund can be a core fund for someone who wants to focus entirely on that niche.

That said, a search of the Securities and Exchange Commission's mutual fund screener found hundreds of different funds that include the word "core" in their names. That shows the popularity of the core fund concept, but it also raises concerns about how well those many funds actually serve as core holdings for a wide range of investors. Marketing aside, you have to assess whether something that calls itself a core fund is truly appropriate for your investing needs.

The core fund concept has become popular not only among mutual funds, but also in the exchange-traded fund world. For instance, the iShares family of ETFs has established a core of 20 funds designed for investors to use to create a diversified portfolio. With ETFs covering U.S. and international stocks, as well as the U.S. bond market, iShares hopes to drive more retail investors toward its core fund offerings while retaining its popularity among institutional investors.

Why invest in core funds?

Source: 401k 2013 via Flickr.

The biggest benefit of using core funds in your portfolio is to maintain investing discipline and ensure that you have a solid foundation to implement your specific financial strategy. Without a core fund philosophy, many investors find themselves owning large numbers of mutual funds that they initially chose based on short-term popularity and performance but that no longer serve a useful role in their overall portfolio. Moreover, even though mutual funds have varying names and often appear to be aimed at achieving different results, their holdings can be similar or even nearly identical, which makes owning multiple funds completely ineffective at generating the diversification that most investors would expect.

One of the best uses of a core fund is within a 401(k) or other employer-sponsored retirement plan. Because 401(k)s have a limited menu of available investment options, an all-purpose core fund is often the best choice to diversify your retirement savings.

Core funds can help simplify your overall investing immensely. Even if you use a portion of your assets to invest in noncore holdings in hopes of better returns, keeping most of your money in a select group of core funds can help you stay on course no matter what the markets throw your way.