Exchange-traded funds (ETFs) are a popular choice among investors to complement mutual funds, individual stocks, and bonds in their portfolios because they offer a number of benefits. However, it is also feasible to assemble an entire portfolio solely from exchange-traded funds (ETFs), which typically track indices across multiple asset classes. In this post, I’ll go over the advantages and drawbacks of using index ETFs to create an ETF-only portfolio. (Although actively managed ETFs are available, the term “all-ETF portfolio” in this article specifically refers to utilizing index ETFs only.) ).
What your goals and preferences are will largely determine whether or not an all-ETF portfolio makes sense for you. ETFs typically offer great diversification at a low operating expense ratio (OER) because many of them are passive investments that follow a particular benchmark index. This is why they usually provide transparency—it’s simple to see what stocks, bonds, or other assets the ETF owns on a daily basis. If these are the only qualities you consider important in an investment, investing only in exchange-traded funds (ETFs) might be a simple but flexible option that is worth investigating further.
There are some trade-offs to think through. Giving up actively managed mutual funds, which can outperform index ETFs through expert stock and bond selection, is necessary to switch to an all-ETF portfolio. Additionally, you will no longer have the control that accompanies having a portfolio made up only of individual securities that you have chosen. Even though these methods also have certain drawbacks, some people won’t want to give them up (see table below). Additionally, you must be at ease with the risks associated with any ETF, such as liquidity and market risk, as well as the ETFs’ costs.
With two major exceptions—ETFs trade differently from index mutual funds and there are ETFs available for some niche asset classes but very few or no index mutual funds—a portfolio of index mutual funds would be very similar to an all-ETF portfolio.
Exchange-traded funds (ETFs) have revolutionized the investing landscape, offering investors a convenient and cost-effective way to gain exposure to a wide range of assets. However, with thousands of ETFs available, determining the optimal number to hold in your portfolio can be a daunting task.
The Importance of Diversification
Diversification is a fundamental principle of investing that aims to mitigate risk by spreading your investments across different asset classes, sectors, and geographies. By diversifying your portfolio, you reduce your exposure to any single asset or market segment, thereby minimizing the impact of any potential losses.
The Role of ETFs in Diversification
ETFs play a crucial role in achieving diversification due to their inherent nature. Each ETF typically tracks a specific index or basket of assets, providing instant exposure to a diversified pool of holdings. This eliminates the need for individual stock picking and allows investors to gain broad market exposure with a single investment.
Finding the Sweet Spot: The Ideal Number of ETFs
While diversification is essential, holding too many ETFs can lead to unnecessary complexity and management challenges. Striking the right balance between diversification and simplicity is key to building an effective ETF portfolio.
Expert Insights: The 5-10 ETF Portfolio
Experts generally recommend holding between 5 and 10 ETFs in a well-diversified portfolio. This range provides sufficient diversification across different asset classes and sectors while keeping the portfolio manageable and easy to track.
Factors to Consider When Determining the Number of ETFs
The optimal number of ETFs for your portfolio will depend on several factors, including:
- Investment goals: Your investment goals will determine the asset allocation of your portfolio and the types of ETFs you should hold.
- Risk tolerance: Your risk tolerance will influence the level of diversification you need. Higher risk tolerance may allow for a more concentrated portfolio with fewer ETFs.
- Investment experience: More experienced investors may be comfortable managing a larger number of ETFs, while beginners may prefer a simpler portfolio with fewer holdings.
Building a Diversified ETF Portfolio
Here are some tips for building a diversified ETF portfolio with the right number of ETFs:
- Start with a core allocation: Begin by allocating your assets across major asset classes such as stocks, bonds, and real estate.
- Consider sector diversification: Within each asset class, consider diversifying across different sectors to mitigate industry-specific risks.
- Add thematic or niche ETFs: Once you have established a core portfolio, you can consider adding thematic or niche ETFs to align with your specific interests or investment goals.
- Rebalance regularly: Regularly review your portfolio and rebalance as needed to maintain your desired asset allocation.
Determining the optimal number of ETFs for your portfolio requires careful consideration of your investment goals, risk tolerance, and experience. By aiming for a range of 5-10 ETFs, you can achieve a well-diversified portfolio that balances risk mitigation with simplicity and manageability. Remember, the key is to strike the right balance between diversification and simplicity to create a portfolio that aligns with your individual investment needs and objectives.
Some pros and cons of four types of portfolios relative to each other Some pros and cons of four types of portfolios relative to each other
- Portfolio
- Pros
- Cons
- Portfolio Actively managed mutual funds
- Advantages: Expert active management; potential to beat the market; well-diversified among a range of securities; most fund options
- Cons: Greater portfolio turnover; less transparency; potential underperformance; higher ongoing expenses
- Portfolio Index mutual funds
- Pros: Generally low ongoing expense; very well-diversified among different securities; aims to match index performance (minus fees and expenses).
- Cons: No active management; limited selection in some asset classes; no chance to outperform the index
- Portfolio All-Index ETF portfolio
- Pros: Exceptionally well-diversified across a range of securities; generally low ongoing expenses; daily transparency into the fund’s composition; trading flexibility; striving to match index performance (minus fees and expenses).
- Cons
- No active management
- No potential to beat the index
- Portfolio Individual stocks and bonds
- Pros
- No ongoing management expenses
- Maximum control
- Complete transparency
- Cons: Higher transaction costs; harder diversification; lack of professional management; low liquidity for some bond types (individual bonds)
Here are three methods for creating an all-ETF portfolio, ranging from extremely basic to highly sophisticated, if you believe it would be appropriate for you.
Keeping it simple
Using two ETFs could be one way to contribute to a diversified, well-balanced stock and bond portfolio:
- A total world stock market ETF
- A total bond market ETF
For example, if you are an investor seeking moderate risk and determine that you would like to allocate 60% of your portfolio to stocks and 60% to bonds, you may want to think about buying an all-country stock index ETF and combining it with a bond ETF.
An index such as the Morgan Stanley Capital International All Country World IndexSM (MSCI ACWI), which offers exposure to U.S. S. stocks, developed-market international stocks, and emerging-market international stocks.
Some bond ETFs track the broad Bloomberg U. S. Aggregate Bond Index, which covers:
- Treasury bonds
- Government-agency bonds
- Mortgage-backed bonds
- Investment-grade corporate bonds
- Some dollar-denominated international bonds.
This kind of portfolio has the benefit of simplicity—it only has one bond fund and one stock fund. It will be simple to determine when rebalancing is necessary. Additionally, a two-ETF portfolio can help you minimize your trading expenses because ETFs trade with a bid/ask spread and trade intraday like stocks. 1.
The lack of fine tuning in this portfolio is one of its drawbacks. As of December 2022, for example, MSCI%20ACWI%20IMI%20had approximately 2059 percent of its stocks in the United States and 2041 percent of its stocks outside the United States, as reported by Morgan Stanley Capital International. You might want two different stock ETFs if, for example, you would rather have a higher allocation to US stocks.
This portfolio’s failure to allocate to Treasury Inflation Protected Securities (TIPS), sub-investment grade bonds (also referred to as junk bonds or high yield bonds), non-dollar international bonds, and other asset classes like commodities and real estate is another disadvantage. Additional asset classes can help further diversify your portfolio. However, the two-ETF portfolio may be a viable option if simplicity is your goal.
How many of the same category ETF should you own?
FAQ
Is it good to have multiple ETFs?
Is 20 ETFs too many?
How many S&P 500 ETFs should I buy?
How much of your money should be in ETFs?
How many ETFs should I invest in?
An intermediate approach to an all-ETF portfolio could consist of about 8 ETFs. An emerging-market ETF. For bonds, you could start with the same core bond ETF described above and diversify further by including ETFs that invest in: International bonds. The advantage of this portfolio is that it can help provide balance.
How many ETFs should be in a portfolio?
Owning five to six ETFs is a “great mix because having more makes it difficult to keep track of it ,” Brott said. “Three core holdings reflecting various concentrations of small medium and large cap U.S. stocks should make up 50% to 70% of the portfolio,” he said. (Video) Is a 3-ETF Portfolio Enough? What ETFs should be in my portfolio?
How many ETFs should a 10K investor have?
1. Keeping it simple. One option you can consider would be using two ETFs to help provide a balanced, diversified portfolio of stocks and bonds: A total world stock market ETF. How many stocks should you own with 10k?
Is one ETF enough?
For some, one ETF can be enough if it’s sufficiently diversified. Take, for instance, Vanguard Total World Stock ETF VT, which includes stocks from around the world. This approach can be a good fit for passive stock investors who prefer the set-it-and-forget-it approach.