ETFs Overlap: A Guide to Building a Diversified Portfolio

Building a diversified portfolio is key to minimizing risks and maximizing returns.

ETFs can overlap in various ways, including sector overlap, where a single ETF tracks multiple sectors, such as technology and healthcare.

Having multiple ETFs in the same sector can lead to unnecessary duplication of holdings, reducing the overall efficiency of your portfolio.

To avoid this, consider using a sector ETF with a broad focus, like the Vanguard Information Technology ETF (VIT), which covers a wide range of tech stocks.

Investors can also experience style overlap, where two ETFs track similar investment styles, such as growth or value.

ETFs have reshaped the investment landscape in recent years, offering investors an efficient and cost-effective means of building diverse portfolios.

ETFs are a popular choice for investors due to their flexibility and low costs, but this popularity has also highlighted a significant concern: ETF overlap.

ETF overlap occurs when multiple ETFs within a portfolio contain similar or identical holdings, which can erode the advantages of diversification.

This issue can have a significant impact on an investor's portfolio, potentially reducing the benefits of diversification and increasing risk.

ETFs have become a staple in many investment portfolios, and understanding ETF overlap is crucial for making informed investment decisions.

The soaring popularity of ETFs has brought attention to the need for investors to carefully manage their portfolios to avoid ETF overlap.

Understanding ETFs can be a bit overwhelming, but let's break it down. It's essential to define the mix of asset classes that suits your investment goals, such as equities, fixed income, real estate, commodities, and alternatives.

Asset allocation is the foundation of a well-diversified ETF portfolio. For example, you may want to allocate 60% to equities, 20% to fixed income, and 20% to real estate. This will help you achieve your investment objectives while managing risk.

To maximize diversification, it's crucial to evaluate the correlation among your portfolio's assets. Tools like ETF Insider can assist in assessing correlations between selected ETFs. This will help you identify low or negative correlations, which is ideal for diversification.

Extreme cases of fund overlap can expose an investor to unexpectedly high levels of company or sector risk. This can distort portfolio returns when compared with a relevant benchmark. For instance, if two separate mutual funds both have overweighted the same stock, it might be worth replacing one of the funds with a similar fund that does not carry that stock as a top holding.

Here are some key factors to consider when evaluating fund overlap:

Regularly reviewing and rebalancing your portfolio is crucial to ensure alignment with your investment goals. This may involve selling ETFs with high overlap and reinvesting in assets that enhance diversification. By doing so, you can minimize risk and maximize returns.

Start by aligning your portfolio with your investment goals and risk tolerance, defining the mix of asset classes that suits your objectives.

To maximize diversification, evaluate the correlation among your portfolio's assets and aim for low or negative correlations. Tools like ETF Insider can assist in assessing correlations between selected ETFs.

Regularly review and rebalance your portfolio to ensure alignment with your investment goals, which may involve selling ETFs with high overlap and reinvesting in assets that enhance diversification.

A good diversification strategy involves diversifying across sectors and industries to avoid overconcentration. Tools like ETF Insider provide sector exposure information, enabling strategic portfolio rebalancing.

To maintain diversification, review your portfolio regularly and adjust your holdings as needed. This is especially important because market movements can change the weightings of holdings in some ETFs.

Here are some key factors to consider when building a diversification strategy:

To build a portfolio, you should start by examining each ETF or managed fund under the hood. Look at the product provider's website to see the specifics of the ETF, including the number of holdings and which sectors and countries are represented.

The next step is to view the individual holdings in the ETFs, such as the top 20, and the percentage of each holding. This will help you identify overlap across your portfolio.

To ensure you're not over-allocating to certain sectors or countries, examine the breakdown of each ETF by sector. This will help you stay within your preferred limits.

When building your portfolio, it's essential to consider the overlap between different ETFs. A common guideline suggests keeping overlap below 50% to maximize diversification benefits.

Investors often wonder how much overlap is acceptable, and the answer varies. However, a general rule of thumb is to keep overlap between ETFs below 50%.

To avoid high overlap, start by examining the product provider's website for each ETF or managed fund in your portfolio. This will give you a clear picture of the number of holdings, sectors, and countries represented.

Looking at the individual holdings in each ETF, such as the top 20 holdings and their percentage of each holding, will help you identify overlap. This information is usually available on the website.

Ensure that the combined stock and sector weightings are within your preferred limits to avoid overlap. This will help you achieve the diversification benefits you're looking for in your portfolio.

A well-diversified portfolio can be a collection of various asset classes, including stocks, bonds, property, and infrastructure.

The example portfolio in this article contains six positions, but it may not be as diversified as it seems. Big Tech companies, such as Microsoft, NVIDIA, Apple, Alphabet, Amazon, and Meta Platforms, make up a significant portion of the portfolio.

The iShares Global 100 ETF holds 100 stocks from various countries, but it's still a relatively small number compared to other options. For instance, the Vanguard MSCI Index International Shares ETF contains 1500 stocks from 23 countries.

Diversification can be improved by removing the individual Microsoft stock, which is already well-represented in the portfolio, and adding new asset classes. This will help protect the portfolio when markets turn.

Here's a breakdown of the Big Tech companies in the example portfolio:

By removing the individual Microsoft stock and adding new asset classes, diversification can be improved and the portfolio can be better protected against market fluctuations.

Knowing your portfolio is key to overcoming overlap. Go to the websites of your product providers and examine the breakdown of the holdings within each ETF.

A simpler portfolio is easier to manage. By keeping it simple, you can ensure each ETF has a particular purpose in the portfolio.

You may think adding more ETFs will provide diversification benefits, but it's actually the opposite for ETFs based on similar indices. There are little to no diversification benefits from adding these types of ETFs.

To ensure your portfolio is diversified, focus on including multiple asset classes such as Australian shares, international shares, bonds, property, infrastructure, and cash.

Minimal overlap in your portfolio is not a problem, as long as you're aware of it and happy with it. If you're mixing and match ETFs to get the exposures you want, that's fine too.

Having lots of ETFs, funds, and stocks can be a problem if you're not sure of how exposed you are to any one share, sector, or country.

A good rule of thumb is to make sure a stock isn't more than 5% of your overall portfolio. This can help prevent overexposure.

In 2022, the ARK Innovation ETF dropped 66% when all its stocks went south at the same time, highlighting the importance of diversification.

Overcoming overlap in your ETF portfolio can be a challenge, but it's not insurmountable. Knowing your portfolio is key, so take the time to visit the websites of your product providers and examine the breakdown of the holdings within each ETF.

A simpler portfolio is easier to manage, and each ETF should have a particular purpose in the portfolio. By keeping things straightforward, you'll be better equipped to tackle overlap head-on.

Adding ETFs based on similar indices won't provide much in the way of diversification benefits. This is a crucial point to keep in mind as you build and maintain your portfolio.

To truly diversify, make sure your portfolio spans multiple asset classes, including Australian shares, international shares, bonds, property, infrastructure, and cash.

Complementary ETFs are key to minimizing overlap in your portfolio. By choosing ETFs that complement each other, you can avoid duplicating holdings and create a more diversified portfolio.

For example, if you're invested in a large-cap, tech-heavy ETF like the Invesco QQQ Trust, you might consider an ETF focused on a different sector, such as a small-cap or mid-cap-focused ETF.

Reviewing your portfolio regularly and adjusting your holdings as needed can help you maintain diversification. This is especially important because market movements can change the weightings of holdings in some ETFs.

Here are some examples of complementary ETFs:

By diversifying across sectors and industries, you can avoid overconcentration and create a more resilient portfolio. This can help you weather market fluctuations and achieve your long-term investment goals.

ETFs overlap can be a concern for investors, but understanding the fundamentals is key to addressing it.

ETF Insider provides up-to-date data on ETFs, including holdings, sector exposure, and assets under management (AUM).

Investors can use this information to visualize their portfolio's composition and assess its diversification potential.

ETF Insider's issuer details and correlations analysis help investors make informed decisions about their investments.

By gaining a deeper understanding of their investments, investors can make more strategic decisions and potentially improve their portfolio's performance.

The SPDR S&P 500 ETF Trust is a popular investment option that offers broad market exposure.

Investors can gain diversification through ETFs like the SPDR S&P 500 ETF Trust.

However, overlapping holdings in ETFs can cause investors to have a concentrated portfolio.

ETFs, including the SPDR S&P 500 ETF Trust, are generally low-cost investments.

Overlapping companies can concentrate your portfolio more than preferred, making it essential to be aware of this risk.

Fund overlap is a situation where an investor owns shares in several mutual funds or exchange-traded funds (ETFs) with overlapping positions. This can create too much concentration in just a few companies' shares, reducing the benefits of diversification for the investor.

For instance, if an investor owns both an S&P 500 index mutual fund and a technology sector ETF, they would be overlapping quite a bit with the FAANG stocks (i.e., Meta, Apple, Amazon, Netflix, and Google), because those stocks are large components of both funds' portfolios.

Extreme cases of fund overlap can expose an investor to unexpectedly high levels of company or sector risk, which can distort portfolio returns when compared with a relevant benchmark. This can be very difficult for a retail investor to keep track of individual fund holdings, but a quarterly or annual check can help investors understand the strategy of each individual fund.

If two separate mutual funds both have overweighted the same stock, it might be worth replacing one of the funds with a similar fund that does not carry that stock as a top holding. This can help mitigate concentration risk and create a better-balanced portfolio.

Fund managers and investors often diversify their investments across asset classes, including stocks and bonds, real estate, ETFs, commodities, short-term investments, and alternative asset classes. They will then diversify among investments within the asset classes, such as by selecting stocks from various sectors that tend to have low return correlation.

Indices and Markets are often used to track the performance of a particular asset class, and in the context of ETFs, they can be a key factor in understanding overlap.

The S&P 500 Index, for example, is a widely followed benchmark that represents the performance of the 500 largest publicly traded companies in the US.

A significant portion of ETFs track the S&P 500, which means that these funds are essentially investing in the same underlying assets.

The MSCI EAFE Index, on the other hand, is a benchmark for developed markets outside of North America and Japan.

Many ETFs track the MSCI EAFE Index, which can lead to overlap with other funds that also invest in international developed markets.

The Vanguard FTSE Developed Markets ETF, for instance, tracks the FTSE Developed All Cap ex US Index, which includes many of the same developed market countries as the MSCI EAFE Index.