75-5-10 Diversification is the diversification test which must be met by mutual funds under the investment company Act of 1940 in order to market themselves as a diversified mutual fund. 75% of the fund’s assets must be invested in other issuer’s securities, no more than 5% of the fund’s assets may be invested in any one company, and the fund may own no more than 10% of an issuer’s outstanding securities.
Applying "75-5-10 Diversification" to Securities Exams:
An investment company maintains a portfolio of assets, and one of the primary reasons an investor buys shares in an investment company is for diversification. In order for the investment company to be classified as diversified it must meet the 75-5-10 rule. In other words the fund’s assets must be invested, the can’t simply be held in cash.
Investors in a mutual fund will achieve diversification through their investment in the fund. However, in order to determine if the fund itself is a diversified fund, the fund must meet certain requirements. The Investment Company Act of 1940 has laid out an asset allocation model that must be followed in order for the fund to call itself a diversified mutual fund. It is known as the 75-5-10 test, and the requirements are as follows:
75%—75% of the fund’s assets must be invested in securities of other
issuers. Cash and cash equivalents are countered as part of the 75%.
A cash equivalent may be a T-bill or a money market instrument.
5%—The investment company may not invest more than 5% of its assets
in any one company.
10%—The investment company may not own more than 10% of any company’s outstanding voting stock.
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