The ideal number of ETFs to hold for most personal investors would be 5 to 10 across asset classes, geographies, and other features. As a result, a certain degree of diversification is possible while keeping things simple.
How many stocks and ETFs should you have in your portfolio?
- There is no single accurate answer to this topic, despite the fact that many sources have an opinion on the “proper” quantity of stocks to purchase.
- The quantity of stocks you should hold is determined by a variety of factors, including your investment time horizon, market conditions, and your proclivity for keeping track of your holdings.
- While there is no universally accepted answer, there is a good range for the ideal amount of stocks to hold in a portfolio: 20 to 30 equities for US investors.
What is diworsification?
The term “diworsification” was coined by Peter Lynch in his book One Up On Wall Street, when he highlighted how some corporations expand into sectors that are unrelated to their core industry. Over time, the word “diworsification” has been used to describe some investors who believe they are diversifying their assets but are actually doing more harm than good. This word has also been used in the context of holding a concentrated basket of companies (say, ten or fifteen) and assuming that this is a superior approach to returns than owning hundreds, if not thousands, of stocks from various industries and nations (i.e., indexing that you can read about here).
Regardless of the context connected with diworsification, or any other phrase that implies a portfolio is far from optimum, most investment decisions should aim to achieve the following:
a solid risk/reward trade-off for the investor that matches with their financial goals and objectives while combating a number of long-term market situations
This means that, depending on your objectives, your financial decisions may differ significantly from those of your neighbor, friend, coworker, family, and so on…
Given some recent reader questions in my inbox and how I utilize ETFs for my own portfolio, today’s column will focus on how many ETFs could be enough for your portfolio.
Your results may vary.
I looked at the Canadian Couch Potato ETF model portfolio, which, as you know, only recommends three ETFs.
What is your rationale for employing a large number of ETFs rather than just a few?
I noticed on your website that you own the Vanguard VYM ETF.
What about another exchange-traded fund (ETF)?
What’s more, how many ETFs should you own in the first place?
Indicators of diworsification
Aside from the obvious signs of diworsification, such as portfolio/investor confusion, greater portfolio management expenses, and worse portfolio returns, there are a few other signs to look for:
- You have an excessive number of stocks in the same industry. Investing solely in Canadian bank stocks, for example, is unlikely to protect you from a range of long-term market circumstances. To eliminate individual stock or sector risk, diversify your portfolio by owning a variety of companies from several industries. This will reduce your investment risk in any one company or industry.
- You have an excessive number of individual stock positions. Benjamin Graham proposed owning between 10 and 30 different firms to fully diversify a stock portfolio in “The Intelligent Investor” (1949). That advice was given many years ago. That advice falls well short of what investment guru Burton Malkiel considers adequate. (It’s worth noting that there’s no clear consensus on how many individual stocks are enough; suffice it to say that 10 is probably too few, and anything approaching 100 is likely too many for any investor to keep track of.)
Here’s a link to a prior piece regarding how many dividend-paying equities I think I need.
Warren Buffett says, “Wide diversification is only necessary when investors don’t know what they’re doing.”
So, how many ETFs are enough?
If we return to the earlier thesis that investing entails risk management, and that we should make financial decisions that are aligned with our financial goals (while navigating a variety of long-term market conditions), you can probably achieve this with just a few funds or Exchange Traded Funds (ETFs) in particular. As a result, many financial gurus (who are proponents of index investing) recommend owning:
I use the word “again” to emphasize my point “Many” is used with caution because there is no clear agreement on how many funds are needed by all investors, or, more crucially, how those money should be allocated.
Consider the following example:
David Swensen is the Chief Investment Officer of the Yale Endowment Fund, one of the most successful institutionally managed portfolios in modern financial history, as some experienced investors may already know.
To be clear, his asset allocation is not at all like any Canadian Couch Potato model!
Is it likely that investing just in the S&P 500, with no Canadian or international equities, will result in a long-term loss of capital?
Is it likely that if you exclusively invested in our Canadian market and held some bonds to combat market downturns, your portfolio will be a huge failure in the long run?
Hardly.
I suspect that if you keep your investing fees low and stick to your investment plan, you’ll be fine.
The truth is that equity returns are connected over long periods of time.
Long term, however, equities returns should outperform bond and cash returns.
Why?
Stocks, on the other hand, are an investment in a future that is largely unknown. As a result, their upswing should yield a good profit! Bonds are essentially a debt. While both stocks and bonds have the potential to go through the floor at the same time, equities offer a larger upside. Keep in mind that risk and reward are linked. By keeping stocks over bonds, and certainly over cash stashed beneath a mattress, you’re taking on significantly more investing risk for far more possible return.
“Before-tax returns are shown in the table above.
The large disparity in returns between the S&P 500 and bonds or T-bills becomes even more pronounced after tax.
Every year, the interest is fully taxable.
The majority of the return on the S&P 500 equities would be capital gains, which are only 50% taxable and do not become taxable until the stock is sold.”
How many ETFs do I own?
Diversification might be a challenge for dividend investors like myself. Always keep the following in mind when investing: “It’s all too often true that the same factors that increase your chances of being wealthy also increase your risks of becoming poor.” William Bernstein, a financial historian, acclaimed author, and neurologist.
In essence, I’ve developed my own Canadian dividend ETF by detaching any big Canadian ETF from its growth and income components.
“The key to your success will be picking stocks from leading companies and holding them for a long time.
While you can’t sleep and there’s a need for watching, there’s no need to panic if a company’s earnings fall short for a year or two.
This is a fairly common occurrence.” Stephen Jarislowsky, author, millionaire businessman, and philanthropist; The Investment Zoo
Consider the case of XDV.
This ETF invests in the 30 highest-yielding dividend-paying firms, with the goal of replicating the Dow Jones Canada Select Dividend Index’s performance, which is based on variables such dividend growth, yield, and average payout ratio.
To date, I’ve managed to establish a portfolio (on my own) that contains roughly 60% of XDV’s holdings.
This ETF now has a large proxy in my portfolio.
I may either own XDV and pay the 0.50 percent management charge, or I can directly own many of the firms as a shareholder and never pay management costs.
The latter is what I’ve selected!
(For the record, I do not own XDV.)
I utilize low-cost ETFs to diversify into the US market outside of Canada for all of the reasons outlined in this book, which I recently reviewed here.
While I own a few U.S. stocks, I believe that investing throughout the U.S. market via ETFs will provide me with superior diversity and long-term profits. For the time being, I’ve simplified my portfolio to rely primarily on the low-cost ETF VTI.
How many ETFs are enough?
For many investors, one (1) all-in-one fund across all accounts may be sufficient.
In general, no more than 4-5 ETFs are likely to be sufficient for long-term diversification and/or retirement income.
Diworsification could certainly be explored if you possess more than ten ETFs. That is not something you should do.
Any firm, counselor, or money coach that encourages you own more should be avoided.
What are your thoughts on exchange-traded funds (ETFs)?
How many ETFs, in particular, are sufficient to help you achieve your objectives?
Should I purchase all ETFs at once?
At the same time Investing all of your money at once is advantageous because:Historically, market patterns show that stock and bond returns outperform cash and bond returns. When markets are rising, putting your money to work as soon as possible allows you to take full advantage of the increase.
Is five ETFs too many?
Experts agree that, in terms of diversification, a portfolio of 5 to 10 ETFs is ideal for most individual investors. However, the quantity of ETFs isn’t the most important factor to consider. Instead, think about how many various sources of risk you’re acquiring with those ETFs.
Are ETFs suitable for novice investors?
Because of their many advantages, such as low expense ratios, ample liquidity, a wide range of investment options, diversification, and a low investment threshold, exchange traded funds (ETFs) are perfect for new investors. ETFs are also ideal vehicles for a variety of trading and investment strategies employed by beginner traders and investors because of these characteristics. The seven finest ETF trading methods for novices, in no particular order, are listed below.
What percentage of my portfolio should be invested in ETFs?
Decide what financial goals you want to achieve before you start investing in exchange traded funds. Which exchange traded funds make the most sense for your portfolio will be determined by how you intend to use the returns from your ETF investments.
Here’s how to figure out how much of each of the four primary types of ETFs to include in your portfolio:
- ETFs that invest in bonds. When you buy a bond ETF, you’re buying a bunch of bonds all at once. Bond ETFs, also known as fixed-income ETFs, are less volatile than stock ETFs, which means their value remains relatively stable over time and may see small gains. This makes them a fantastic choice if you want to add stability to your portfolio or have a shorter investing horizon. If you only have a few years to invest, you should have at least 70% of your portfolio in bonds.
- ETFs that invest in stocks. Stock ETFs make sense for investing for long-term goals, such as retirement, because they carry a higher risk than bond funds but give higher returns. If you’re decades away from your financial goals, you should invest mostly in stocks to maximize your money’s growth potential.
- ETFs that invest in other countries. Investing in international stocks and bonds diversifies your portfolio even further. International exchange-traded funds (ETFs) provide convenient access to companies based outside of the United States, as well as forex (currency) trading. International ETFs should make up no more than 30% of your bond assets and 40% of your stock investments, according to Vanguard.
- Sector ETFs: If you want to focus your exchange-traded fund investment strategy on a certain sector or industry, sector ETFs are a good option. You can increase your development potential by investing in specialized industries, such as healthcare or energy. However, there are higher dangers with this strategyfor example, the entire tech industry could undergo a slowdown at the same time, harming your investment considerably more than if you owned a broad market ETF with limited exposure to tech. As a result, sector ETFs should only account for a small amount of your overall portfolio.
Understanding your timeline is crucial to setting your financial objectives when investing in exchange traded funds. When will you need to start withdrawing funds from your investment portfolio? Consider less hazardous ETF options if you need money sooner, such as for a down payment on a property. You may afford to take on more risk with stock ETFs if you’re investing in ETFs for a long-term goal, such as retirement.
Is it worthwhile to purchase one share of stock?
When an investor has found a stock that is worth buying, he or she should use a brokerage account to make an online trade. The market order and the limit order are the two sorts of trades that can be placed in this scenario. A round lot is a stock that trades in multiples of 100 shares. Orders for less than 100 shares are referred to as odd lots.
When an investor places a market order, they are requesting that the stock be purchased at the current market price. When an investor places a limit order, they are deciding to hold off on purchasing the stock until the price falls below a certain threshold. While buying a single share isn’t a good idea, if an investor really wants to buy one, they should try to put a limit order to increase the chances of capital gains that will cover the brokerage fees.
Commissions are fees imposed for each transaction up to a certain amount of shares purchased or sold. The majority of individuals choose to spread their commission charges over a large number of shares in order to lower their average fee prices.
What percentage of my portfolio should be REITs?
In general, REITs should not account for more than 25% of a well-diversified dividend stock portfolio, depending on your specific objectives (such as the portfolio yield and long-term dividend growth rate you seek, as well as your tolerance for risk).