The gravitational pull of exchange-traded funds (ETFs) has created a wave of new investors in these products over the last several years. Many may be rotating away from traditional high fee mutual funds, while others are looking to simplify their individual stock or bond portfolios.

One question I am often asked by new ETF adopters is: how many funds should they own to create a properly diversified and balanced portfolio?

It’s worth remembering that, at their core, most ETFs are highly diversified investment vehicles. Many popular indexes own hundreds (if not thousands) of publicly traded stocks or fixed-income instruments. This means that you don’t necessarily have to work overtime in your search for far-reaching exposure to global markets.

If your goal is simplicity, you may only want to own a single fund for each asset class in your portfolio. For instance, the following six funds provide ultra-low cost exposure to popular groups of stocks, bonds, and commodities:

  • Domestic Stocks: iShares Core S&P Total U.S. Stock Market ETF (ITOT)
  • International Stocks: iShares Core International Stock Market ETF (IXUS)
  • Domestic Bonds: Vanguard Total Bond Market ETF (BND)
  • International Bonds: Vanguard Total International Bond ETF (BNDX)
  • Commodities: iPath Bloomberg Commodity Index Total Return ETN (DJP)
  • Real Estate: Schwab U.S. REIT ETF (SCHH)

For those that are interested in fine-tuning their portfolio towards a specific theme or adjusting their exposure within a particular asset class, a more comprehensive approach may be warranted. This may include expanding your horizons to hone in on select ETFs that offer a fundamental index construction methodology or simply a sector that you feel will outperform given the prevailing market currents.

In those instances, it may be appropriate to branch out your exposure to include a small subset of tactical positions that have the potential to outperform the broader market overall. More complex ETF portfolios may have as many as 10 or 15 positions that provide nuanced exposure to specific opportunities.

For instance, the iShares iBoxx High Yield Corporate Bond ETF (HYG) may be a potential fund to own if you are looking to enhance the yield of your portfolio with more credit sensitive holdings than a broad-based bond fund. Similarly, an overweight focus on stocks exhibiting value characteristics may include adding a fund such as the iShares Russell 1000 Value ETF (IWD). Both are examples of ways to use ETFs with a precise focus to expand upon your existing core positions.

The biggest mistakes I see investors make is having far too many ETFs in their portfolio. Owning more than 15 funds is likely going to create more overlap than you realize and will also make tracking each position much harder on a monthly, quarterly, or year-over-year basis.

In addition, trying to be too crafty with owning multiple funds in complimentary segments such a small, mid, and large-cap stocks will likely lead to a similar outcome as owning one broad-based position like ITOT. The advantage of those individual holdings becomes misplaced unless you are aiming to eliminate a segment of the market that you feel does not meet your overarching criteria.

The Bottom Line

For those that are just getting acclimated to the ETF world, my advice is to start with a small number of holdings in well-known indexes that demonstrate a high degree of liquidity and low fees. You can often carry larger position sizes in these holdings and achieve a diversified asset allocation profile that meets your risk tolerance and goals. More funds will often complicate your life to the extent that you get caught up in the weeds of managing individual positions rather than focusing on the big picture.

Lastly, it may make sense to research if your brokerage provider has a list of transaction-free ETFs that will further reduce your portfolio fees. These funds are often available in the type of broad-market styles that were mentioned above.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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