How many ETF's should I have in my portfolio?

Question

Hey! I'm just setting up my portfolio and want to do a big lump sum, i'm getting carried away with how many ETF's I have added and I know it's not sensible feasible to add to so many each month? How many ETF's is the logical amount in a portfolio?

Answer

Hey Emma, great question!

Sorry to say this but there’s no right answer here :)

The logical amount is the number you feel comfortable with and what is practical for you to manage on a regular basis, while having exposure to the investments you want.  For some people, that can be done with 1 or 2 ETFs.  For others, it’s more like 4-5.  So it really comes back to where you want your money to be invested.

What I will say is it’s much better to start off slowly and simply.  So you might want to start with just one or two main ones and go from there.  More is definitely not better.  So choose sparingly, and make sure there’s a very good reason for adding each one to your portfolio.

Each one adds extra paperwork, tax admin, mental strain + ongoing management.  Might not seem like much at first, but I’ve been there before and ended up with a messy portfolio that I later trimmed down to make it nice and simple, and much happier for it.

Hope that helps.

Answer

Hey Emma!

That’s a great question — and one I field a lot from Rask Core members.

(Side note: as always, the information included in comments here are strictly general in nature. This is important because as the answers will suggest, it’s personal.)

Lump sum. At Rask, we general advice is to avoid lump sum investing as the timing of it can be very risky. To minimise regret, we advocate for a dollar-cost averaging approach (little bits, lots of times, starting small, over many years).

Number of ETFs

As Dave said, I find this is what an investor feels comfortable with. And the approach will change over time — that’s okay.

Let me offer an example…

In past we had members at Rask who joined more than one of our memberships (e.g. the one of shares, one for ETFs… etc.) and what they would do is buy literally everything we researched over 1-2 years. At first it seems great. «Oh, that stock or ETF sounds really interesting — I’ll buy it.» Do that for two years, though, and across two memberships, and they end up with 10-20 ETFs and 20-30 stocks.

In other words, a LOT of positions and lots of complicated tax returns.

It’s a natural reaction and I think this goes back to the old stock market adage that ‘to be diversified, you need 30 different stocks’. This comes from some studies showing after 30 different positions the benefit of more diversification wears off.

However…

As the mighty Dave Gow alluded to (below/above) the invention of ETFs changed the game — because some index fund ETFs (e.g. VAS, VGS, A200, IVV, VIF, IAF, NDQ, etc.) — can sometimes offer exposure to dozens or even hundreds of different investments with one position.

For example, Vanguard VAS has ~300 different Aussie shares inside of it, whereas IVV has ~500 US stocks. Then there are the super popular «diversified» ETFs like VDHG. These diversified ETFs have multiple other types of things inside them (some Aussie stocks, US stocks, global stocks, Aussie bonds, emerging markets stocks, etc.).

In the diversified ETF example, an investor having 3+ of them might be too much of… the same thing (again, each ETF or share will require tax reporting at EOFY / June 30th). The ‘overlap’ would be too high. So they might consider one diversified ETF is enough for the ‘Core’ of a portfolio (FYI – at Rask we advocate for a Core &amp; Satellite approach). Then, the investor might ‘have some fun’ (I hate saying it like that, but it’s true) by adding some individual stocks or thematic ETFs or other things around the edges as smaller positions.

The next level (of complexity) of investor might choose 3-5 ETFs and build their own Core portfolio instead of using an out-of-the-box solution (i.e. diversified ETF). Because there are more ETFs in this example, it’s slightly more hands on. But it can have tax benefits.

Finally, a pro investor or someone with experience might opt to fully build their own portfolio mostly of direct shares (e.g. «I’ll buy Google and Apple shares, but I won’t buy Microsoft»). More and more I see these types of investors slowly using ETFs for at least some of their Core.

As you can see by my examples, there’s no ‘one size fits all’. As we say on the Rask podcasts time and again, investing comes back to our time, inclination and curiosity. Investors who make time to learn about and manage investments, like the idea of it and keep coming back, and are eager to understand how the investing machine works — are more likely to be more active in their approach. But most people, I find, tend to want to sleep easy having a simple Core portfolio, and then tinker around the edges as they grow.

I’m sorry I can’t answer the question specifically for you (not only is that illegal under the finance law, you can see it’s also not ‘one size fits all’).

Answer

G’day Emma,

Some great answers already, from Dave and Owen.

I’ll throw my metaphorical 2c in, which will variously agree and provide alternative perspectives to those two fine gentlemen.

First, because I work for a company with an AFSL (The Motley Fool), let me say that whatever follows is general, not personal advice, and you should consider how it suits your circumstances.

Okay, with that (important) boilerplate out of the way…

The answer is ‘it depends’. Or, (slightly) more helpfully — an ETF portfolio should have  ‘enough’, but needn’t have ‘too many’.

And, of course, it depends which ETFs, both in terms of how diversified each ETF is and the degree to which they’re different from each other.

For example, five ETFs which (hypothetically) each covered the ‘laser clinic’ industry in Australia would each own just one company — and it’d be the same one!

But a ‘US Total Market ETF’ and a ‘Developed World ex-US’ give you the whole developed world (which is a very, very large proportion of the value of all world stock markets) in just two ETFs, and you may decide that’s all you need.

My take (and spoiler alert, The Motley Fool will have more on this in just a few days) is that you could created a low-cost, well-diversified, broad-based index ETF portfolio with 3 – 5 ETFs.

I hope that’s added to what Owen and Dave have said, and that it’s helpful.

Scott.

(CIO, The Motley Fool)

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Dave Gow - Strong Money Australia

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