How Much ETF Overlap Is Too Much for Your Portfolio?

Exchange Traded Funds (ETFs) have become a popular investment vehicle for individuals seeking broad market exposure and diversification. These funds hold a basket of assets, like stocks or bonds, providing exposure to numerous securities through a single investment. While the goal of investing in ETFs is often diversification, “overlap” can unintentionally counteract this. Overlap occurs when an investor holds too many of the same underlying investments across different ETFs.

Understanding ETF Overlap

ETF overlap happens when multiple exchange-traded funds in a portfolio contain the same underlying securities. This can lead to concentrated exposure to specific companies, sectors, or asset classes, even if an investor holds several different ETFs. For instance, owning both an S&P 500 tracking ETF and a total U.S. stock market ETF creates significant overlap, as S&P 500 companies form a large part of the U.S. market. Similarly, a broad market ETF alongside a technology-focused ETF will likely have amplified exposure to large tech companies already in the S&P 500. The underlying assets are largely the same, leading to unintended concentration of risk.

Identifying Overlap in Your Portfolio

Identifying ETF overlap involves reviewing the underlying holdings of each fund. Many online brokerage platforms offer portfolio analysis tools that show the actual securities held within ETFs, providing insights into asset allocation, sector concentration, and company exposures.

Third-party financial websites also provide free resources to analyze ETF holdings. Users can input multiple ETF tickers to generate reports detailing common holdings and overlap percentages. Investors can also manually check fact sheets or fund websites for individual ETFs, which typically list top holdings for side-by-side comparison.

Another method is observing how different ETFs perform relative to each other. If two or more ETFs consistently move in similar patterns, it may indicate high correlation in their underlying assets and potential overlap. While a direct overlap percentage is more precise, correlated performance can signal the need for further investigation into the underlying holdings.

Implications of Portfolio Overlap

Excessive ETF overlap can have several consequences for an investor’s portfolio. A primary concern is the reduction of genuine diversification, which is often the main reason investors choose ETFs. When multiple ETFs hold the same underlying assets, the portfolio becomes more concentrated than intended, negating the benefit of spreading risk.

This concentration leads to increased concentration risk, meaning the portfolio becomes overly exposed to a smaller set of companies or sectors. If these overlapping investments experience a downturn, the impact on the entire portfolio can be more severe than if truly diversified. Such heightened exposure can result in diminished risk-adjusted returns.

Holding highly overlapping ETFs also leads to unnecessary fees. ETFs charge an expense ratio, an annual fee based on assets managed. If an investor holds multiple ETFs that essentially own the same stocks, they pay management fees multiple times for the same exposure. This duplication of costs can erode overall returns over time, making the investment less efficient.

Managing ETF Overlap

Managing ETF overlap involves strategic planning and regular portfolio maintenance. One effective strategy is careful ETF selection, choosing funds with complementary investment mandates rather than similar ones. For example, combining a broad-market ETF that tracks the total U.S. stock market with an international equity ETF can provide broader diversification without significant internal overlap. This approach ensures each ETF serves a distinct purpose in the portfolio.

A core-satellite approach can be useful, allocating a substantial portion of the portfolio to broad, diversified “core” ETFs that offer exposure to major asset classes or markets. A smaller “satellite” portion is then used for more specialized or thematic ETFs, such as those focusing on specific sectors, regions, or investment styles. This structure allows for targeted exposure while maintaining a diversified foundation.

Regular portfolio review is also essential, especially after making new investments or significant market changes. Periodically reviewing ETF holdings, perhaps quarterly or semi-annually, helps identify any emerging overlaps. This proactive review allows investors to make adjustments, such as rebalancing or consolidating positions, to maintain their desired level of diversification.

Understanding the fund mandates of each ETF before investing is a preventative measure against overlap. Investors should thoroughly research what assets an ETF is designed to hold and its investment strategy. This due diligence ensures that each chosen ETF contributes uniquely to the portfolio’s overall diversification goals and aligns with the investor’s risk tolerance. If significant overlap is identified, consolidating highly redundant positions into a single, broader ETF can streamline the portfolio and reduce unnecessary complexity and duplicated fees.