How Many Different ETFs Should I Own?

Investing in Exchange Traded Funds (ETFs) has become a popular strategy for diversified portfolios. The optimal number of ETFs to hold is a common question. There is no single answer, as the ideal count depends on an individual’s financial situation and investment objectives. Understanding how ETFs align with personal circumstances determines the appropriate number for your portfolio.

Understanding Diversification with ETFs

Diversification mitigates risk by spreading investments across various assets. This strategy reduces the impact of poor performance from any single investment on the overall portfolio. ETFs offer a straightforward way to achieve diversification, as each ETF holds a basket of underlying securities, such as stocks, bonds, or commodities.

An ETF designed to track a broad market index provides exposure to numerous companies across different sectors within a single investment. This built-in diversification is more accessible and cost-effective than purchasing individual stocks or bonds. Investors can diversify within an asset class, like holding both large-cap and small-cap equity ETFs, or across asset classes by combining equity ETFs with bond ETFs.

The goal of using ETFs for diversification is not simply to accumulate many funds. Instead, it focuses on effective diversification aligned with specific investment objectives and appropriate risk management. Each additional ETF should contribute to a more robust, balanced portfolio, avoiding unnecessary overlap or complexity.

Key Factors Influencing Your ETF Count

Several personal and financial considerations directly influence the appropriate number of ETFs for an individual’s portfolio. Investment goals serve as a primary guide, as saving for retirement, a home down payment, or a child’s education may necessitate different asset allocations. Long-term growth objectives might favor equity-heavy ETFs, while shorter-term goals could benefit from more conservative bond allocations.

An investor’s risk tolerance also plays a significant role in determining the ideal ETF count. Individuals comfortable with higher market fluctuations might opt for fewer, more concentrated ETFs that offer higher growth potential but also higher volatility. Conversely, those with lower risk tolerance may prefer broader diversification across numerous ETFs to cushion against market downturns.

The time horizon for investments shapes ETF selection. Longer periods, like decades until retirement, allow for more aggressive portfolios with higher equity ETF allocation. Shorter horizons, such as saving for a purchase within a few years, call for more conservative, liquid investments, potentially with more bond ETFs to reduce volatility.

The total investment amount also influences strategy. Smaller portfolios benefit from broad, all-in-one ETFs, while larger portfolios can accommodate more specialized diversification.

Portfolio complexity is another practical consideration. Some investors prefer a simpler approach with fewer holdings, requiring less monitoring and rebalancing. Others are comfortable with a more intricate portfolio, allowing finer control over asset allocation and specific market exposures. This preference should guide the number of ETFs held.

Approaches to Building an ETF Portfolio

Different strategies for constructing an ETF portfolio lead to varying numbers of holdings, each suited to different investor needs and preferences. A simple, core portfolio consists of just one to three ETFs, providing broad market exposure with minimal effort. For instance, an investor might use a single total U.S. stock market ETF and a total U.S. bond market ETF to cover a significant portion of the investable universe. This approach is particularly effective for those with smaller portfolios or a preference for simplicity, offering substantial diversification without complexity.

Expanding on the core concept, a diversified core portfolio includes three to seven ETFs. This strategy allows for more granular control over asset allocation by adding specific asset classes or geographic regions. An investor might include international equity ETFs, sector-specific ETFs, or different types of bond ETFs, such as corporate or municipal bonds, to further tailor their exposure. This approach aims to enhance diversification beyond broad market funds, potentially capturing opportunities in specific segments or mitigating risks more precisely.

Strategic or specialized portfolios can involve seven or more ETFs, catering to specific market views or advanced asset allocation needs. This might include thematic ETFs focusing on emerging technologies, sector-specific funds, or alternative asset ETFs like REITs or commodities. These portfolios demand research and active management to ensure holdings align with investment objectives and avoid unintended overlap. Careful assessment of each ETF’s underlying holdings is necessary to avoid redundancy, as adding more ETFs does not guarantee better diversification if they hold similar assets.

For example, two technology ETFs might hold many of the same large-cap tech companies, leading to concentrated exposure rather than true diversification. Understanding the correlation between different ETFs is important to building an effective portfolio. The aim is to achieve efficient diversification, where each additional ETF contributes meaningfully to the portfolio’s overall risk-adjusted return, rather than merely increasing holdings.

Evaluating Your ETF Holdings

Periodically reviewing your ETF portfolio ensures alignment with financial objectives and effective diversification. Financial advisors recommend annual or semi-annual reviews to assess performance and confirm asset allocation meets your needs. This check-up identifies significant deviations from target percentages for different asset classes.

Rebalancing is a common practice during reviews, adjusting your portfolio back to its original target asset allocation. For example, if equities perform well and represent a larger percentage than intended, sell equity ETF units and buy bond ETF units to restore balance. This process helps maintain your desired risk level and prevents any single asset class from dominating your portfolio.

Consider if your current ETF allocation aligns with evolving financial goals, risk tolerance, or investment time horizon. Life events, such as career changes or approaching retirement, can alter your financial landscape and necessitate investment strategy adjustments. Ensure your ETFs support updated objectives. As your portfolio grows or changes, periodically check for unintended overlap between ETF holdings.