Do you have too many exchange-traded funds in your investment portfolio?
Having a diversified investment portfolio is important for growth as well as hedging risks. Since ETFs already hold a variety of stocks within a sector or across the market, how many ETFs do you need to get the benefits of a diversified value asset allocation?
A basket of stocks
Think of an ETF as a basket holding multiple equities, bonds, real estate investment trusts or other assets. ETFs can be an easy way for individual investors and smaller investors to get diversification since they contain a variety of assets. On stock investing platforms such as Robinhood (HOOD, Financial), fractional shares of some ETFs are available, making it even more affordable to start investing.
ETFs number in the thousands – some focus on stocks within sectors such as consumer products, energy or health care. Others target the S&P 500, foreign stocks, bonds, real estate investment trusts, growth stocks and more.
Since most ETFs are passively managed, their fees are low.
But how many ETFs should be in my portfolio?
An investor could buy shares of only one mutual fund and have a fairly diversified portfolio, depending on the investments included in that particular ETF. The Vanguard Total Stock Market Index Fund ETF (VTI, Financial), for example, would give an investor a selection of stocks from across the market. Over the past decade, it has seen a rise of more than 14%.
Financial experts say that a portfolio should have anywhere from eight to 60 different stocks in it to be diversified. Since mutual funds can include investments in tens or even hundreds of stocks and other assets, a portfolio could be diversified with only one mutual fund.
With so many different types of mutual funds, some advise having shares of at least eight different mutual funds or ETFs. That could be enough to be confusing. Simpler but well-diversified ETF portfolios can have far fewer individual ETFs and still make impressive gains over time.
Here are some questions you should ask about the number of mutual funds to include in your portfolio.
What’s my risk tolerance?
ETFs take out some of the risk of investing since there are multiple stocks in their baskets. When one stock is down, others might rise, giving an investor growth over time. Generally, ETFs across the market carry less risk than ETFs in a sector since similar stocks in the same sector could all fall at the same time.
What’s in an ETF’s portfolio?
The number of different ETFs that should be in your portfolio depends on what is in each ETF. You could own fewer different types of ETFs if those funds have profitable and diversified portfolios and aren’t devoted to any one investment sector.
Do my ETFs overlap?
One danger in ETF investing is that multiple funds may own some of the same stocks. For example, if several of the ETFs you invest in own shares of Microsoft (MSFT, Financial), you might be overexposed to that stock.
Do I need to rebalance?
Value investors keep their long-term investment goals in mind. Over time, some ETFs will perform better than others. Just as if you own individual stocks, you should rebalance your ETF portfolio annually. This is especially true for those who reinvest dividends in their ETFs.
Am I diversified enough?
Building a diversified portfolio is easy with ETFs since you can pair up different types. A simple ETF portfolio with diversified asset allocation could be Vanguard S&P 500 Index ETF (VOO, Financial), Vanguard Total International Stock ETF (VXUS, Financial), Vanguard Total Bond Market ETF (BND, Financial) and Vanguard Value ETF (VTV, Financial), varying the amounts invested in each fund to suit your risk tolerance.
And that’s a portfolio with just four low-fee Vanguard ETFs.
Remember that the riskiest investment anyone can make is buying the shares of just one company. You can take some of the bumps out of investing by simplifying diversification through ETF investing.
