This week is going to be pretty short and to the point! Didn’t have time for a novel this week, we have been busy!
I wanted to review a topic that may not be very apparent to investors, especially those who don’t work with an advisor, those who are not interested in financial markets or young investors who are just starting out.
The world of ETFs is amazing, and by and large, ETFs are my favorite way for investors to get broad-based exposure to any asset class. However, it is important to be wary of redundancy in a portfolio.
There are now thousands of different ETFs, and many of them have significant overlap.
It is not uncommon to see someone allocating to a portfolio with ETFS like this: S&P 500 ETF, S&P Growth ETF, S&P 500 Value ETF, Large Cap US ETF, Large Cap ESG Aware ETF, and Total US Stock Market ETF.
If you overlaid each of these funds’ charts, you’d see they are nearly identical! This portfolio of 6 different ETFs is not nearly as diversified as you might think!
Especially given that the main theme here is large-cap US stocks.
The same goes for ETF issuers: Vanguard, SPDR, and BlackRock all have their own versions of S&P 500 ETFs. Using all three does not provide any additional layer of diversification!
While this may seem silly to seasoned market veterans, it is not as apparent to people who may just be starting. It is always a good idea to know what companies your ETFs are actually holding, as well as what index they are set to track.
Below is an overview of an S&P 500 ETF along with a Total US Stock Market ETF:
While yes, the fund on the right, the Total US Market ETF, includes some small and mid-cap companies, it is dominated by the same mega-cap companies in the S&P 500 ETF. Additionally, you’ll note that the weighting of these companies is generally the same as well! So, not just the positions themselves, but how much of each position is owned by the ETF is similar.
When it comes to portfolio construction, it is important to take a second look before allocating. There are just so many ETFs today. We are even seeing the rise of personality ETFs, but that is for another time.
Always do some due diligence or speak with a professional to ensure you are not falling for the illusion of diversification!