ETFs
How many ETFs should you have in your portfolio?
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Investment advice can quickly start to feel overwhelming. It’s getting worse when financial experts throw around terms you don’t understand.
One term you definitely need to know is exchange-traded funds, or ETFs. These are simply funds that own many investments, such as a specific type of stock, or a collection of bonds, or even gold.
Many of them already offer great diversification, which begs the question: how many ETFs do you really need in your portfolio?
As with most financial questions, the answer is, “It depends.”
Control vs Simplicity
At the extreme end of the spectrum, you could invest in a single ETF and call it a day.
Seriously, the Vanguard Total Stock Market ETF (VTI) provides broad exposure to the US stock market. This includes all industries and all market capitalizations (company sizes). An investor who only wants to invest in the U.S. stock market might be satisfied with having just one ETF in their portfolio.
If you want to add foreign companies to the mix, you can add stocks of Vanguard FTSE All-World ex-US ETF (WANTED).
So why doesn’t everyone just invest in one or two ETFs to keep their portfolio simple?
Some investors want more granular control over their portfolio. Perhaps they want to invest more in small-cap U.S. stocks or emerging market stocks.
The more ETFs you add to your portfolio, the more control you have over your asset allocation. Take this desire for detailed control even further and you can invest in individual stocks.
The Downside of Too Many ETFs
Everyone likes more control. But control comes at a cost.
First, it adds complexity to your portfolio. What might start as four or five ETFs could easily grow to 40 or 50. One day you log into your account and realize you have more investments than you can easily keep track of at a glance.
Adding more ETFs to your portfolio also increases the risk of unintended overlap. Several of your ETFs probably own the same companies. What started as an attempt at control could actually expose you to a few giant corporations like Apple, Microsoft or Alphabet.
Finally, more ETFs generally mean more fees. The simplest and broadest ETFs generally charge almost no fees. For example, the Vanguard Total Stock Market ETF charges an expense ratio (annual fee) of just 0.03%. Meanwhile, the Vanguard FTSE All-World ex-US ETF charges a bit more at 0.07%. As you invest in smaller, more specialized ETFs, expect expense ratios to increase.
Beyond actions
One or two ETFs might work if you want to invest only in stocks. But what if you also want to invest in bonds? Precious metals? Real estate?
You can invest in ETFs that give you broad exposure to any of these investments. And of course, they add to the total number of ETFs in your portfolio.
It all comes back to simplicity rather than control of your wallet.
A contrarian approach to index funds
Many ETFs mimic certain stock indexes, such as the S&P 500 for large-cap U.S. stocks or the Russell 2000 for similar small-cap stocks. These offer diversification at a low expense ratio.
But some financial experts have begun to express concerns that too many retail investors are blindly investing in index funds. Whatever your personal opinion of Elon Musk, he has raised several thoughtful questions. warnings about index funds.
One concern is that they are blindly investing too much money in the world’s largest companies, based on the weighting of stock indexes. One option – if you want to reduce your exposure to a few gigantic companies – is to invest in equal-weighted funds, providing equal exposure to all companies in the fund rather than weighting based on market capitalization.
Nonetheless, ETFs offer a simple way to diversify your portfolio inexpensively. When in doubt, schedule a flat-rate phone call with a financial advisor to get expert advice on how to invest to achieve your personal goals.
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