How many ETFs are enough?
Can you have diworsification?
Absolutely. When you have too many ETFs.
How many ETFs are enough?
I have my answer.
Read on!
What is diworsification?
It’s the evil cousin to diversification in your portfolio.
Diworsification is the term that was popularized by Peter Lynch in his book One Up On Wall Street – when he discussed that some companies tend to expand into areas widely different than their core business. Over the years this diworsification term has been leveraged to describe some investors who believe they are diversifying their assets but may be doing more harm than good in the process. This term has also used in context of holding a concentrated basket of stocks (say 10 or 15) and believing this is a better approach to returns beyond owning hundreds if not thousands of stocks from various sectors and countries (i.e., indexing that you can read about here).
Regardless of the context associated with diworsification, or any other term that suggests a portfolio is far from optimized, you can probably appreciate that most investment choices should try to achieve the following:
a good risk/reward trade-off for the investor such that this choice aligns with their financial goals and objectives while combating a variety of long-term market conditions.
This means depending upon your goals your financial decisions could be vastly different than your neighbour, your friend, your co-worker, your family and the list goes on…
So, today’s post will highlight how many ETFs might be enough for your portfolio, given some reader questions in my inbox and how I use ETFs for my own portfolio.
Your mileage may vary!
Hi again Mark,
I’ve looked at the Canadian Couch Potato model portfolio for ETFs which proposes only 3 ETFs as you know. What is your rationale for using many ETFs versus just a few?
Hi Mark,
I’ve read on your site you own a few ETFs. How many ETFs should you own anyhow?
Indicators of diworsification
Beyond the obvious such as portfolio/investor confusion, increased portfolio management costs and lowering your portfolio returns, here are a couple of indicators that you might have diworsified your portfolio:
- You own too many stocks from the same sector. Example, owning just Canadian bank stocks is probably insufficient to weather a variety of long-term market conditions. To avoid individual stock or sector risk, you should consider owning many companies from many sectors to decrease your investment risk in any particular company or sector.
- You have too many individual stock positions. I recall from “The Intelligent Investor” (1949), Benjamin Graham suggested owning between 10 and 30 different companies to adequately diversify a stock portfolio. That guidance was provided decades ago. That guidance is nowhere near what Burton Malkiel, an index investing guru, believes is sufficient. (It should be noted there really is no clear consensus on how many individual stocks are enough but suffice to say 10 stocks might be too few and anything approaching 100 or more is likely too many for any investor to keep track of.)
Here is a previous article about how many dividend paying stocks I believe are enough for me.
“Wide diversification is only required when investors do not understand what they are doing” – Warren Buffett.
Fair Warren, but there is nobody like you!
So, how many ETFs are enough?
If we go back to the earlier thesis that investing involves risk management, such that we should make our financial choices so they are aligned to our financial goals (while combating a variety of long-term market conditions) then you can likely accomplish this with just a few funds or Exchange Traded Funds (ETFs) in particular.
That means many financial experts (who are fans of index investing) generally endorse owning:
- A domestic stock fund
- A U.S. stock fund
- An international stock fund
- A domestic bond fund.
Again, I use the word “many” with great discretion because there is also no clear consensus on how many funds nor more importantly in what allocation are those funds necessary for all investors. Case in point:
Some experienced investors might already know that in the past, David Swensen (Chief Investment Officer of the Yale Endowment Fund) was lauded as one of the most successful institutionally managed portfolios in modern financial history.
Just so you know…his asset allocation is very different than any Canadian Couch Potato model!
From my blogpost on where I disagree with Mr. Swensen:
Is your portfolio going to fail long-term if you invested in just the S&P 500 and not any Canadian stocks or international stocks?
Is your portfolio going to be a massive failure long-term if you only invested in our Canadian market and held some bonds to combat market down turns?
Hardly.
If you keep your investing costs low and stick to your investing plan I suspect you’ll do just fine regardless.
The truth is, over many years of investing, equity returns are correlated. Conversely, equity returns should be greater than those delivered by bonds and certainly cash long term. Why? Well, stocks are an investment in a future that is very, rather, extremely unknown. This means their upside should command a good return! Bonds are in simple terms a loan. While both stocks and bonds can fall through the floor at the same time, equities by and large have a greater upside because of modern capitalism as we know it.
Remember risk and returns are related. With stocks you’re taking on far more investment risk for more potential reward by holding them over bonds and definitely over cash hoarded under a mattress.
Image source TaxTips.ca
“The above table shows before-tax returns. The big difference between the returns on the S&P 500 and bonds or T-bills becomes even bigger after tax. The interest is 100% taxable every year. Most of the return on the S&P 500 stocks would be capital gains, which is only 50% taxable, and is not taxable until the investment is sold.”
How many ETFs do I own?
Only a handful, meaning definitely less than five!! At the time of this post I only own three and I’m likely to simplify more over time.
For dividend investors and stock owners like me ample diversification can be an issue.
Always remember with investing:
…“it is all too often true that the same things that maximize your chances of getting rich also maximize your chances of getting poor.” – Financial historian, celebrated author and neurologist William Bernstein.
So, with that in mind in Canada at least, I’ve created my own Canadian ETF by unbundling stocks to my own liking for growth and income.
“The crux of your success will be selecting leading companies’ stocks and then holding on to them for many years. While you cannot go to sleep, and there is a place for monitoring, there is no reason to panic if a firm has earnings that fall short in a given year or two. This is quite a normal phenomenon.” – Stephen Jarislowsky, The Investment Zoo; author, billionaire businessman, philanthropist.
Take XDV for example.
This ETF is comprised of the 30 highest yielding dividend paying companies seeking to replicate the performance of the Dow Jones Canada Select Dividend Index, based on factors such as stable dividend growth, yield and average payout ratio. To date, I’ve managed to build a portfolio (on my own) that includes about 60% of the companies held by XDV. I now own a big proxy of this ETF.
Either I can own XDV and pay the management fee of 0.50% or so every year OR I can own many of the companies directly as a shareholder and never pay management fees. I’ve chosen the latter!
(I do not own XDV for the record.)
While I do own a few U.S. stocks I believe I’ll have better diversification and long-term returns by investing across the U.S. and international market using ETFs as part of my overall portfolio.
There are many great funds to own the U.S. market here.
How many ETFs are enough?
For many investors one (1) all-in-one fund across all your investing accounts could be enough!
In general my answer is no more than 4-5 ETFs are likely enough for both diversification and/or retirement income needs for life.
Certainly, if an advisor suggests more than 5 funds or ETFs that could be considered diworsification depending on those choices. Don’t do that.
I wouldn’t bother with any firm, advisor or money manager firm that suggests you own too many ETFs.
What do you make of ETFs? In particular, how many ETFs are enough to help you realize your goals?
Mark
My name is Mark Seed - the founder, editor and owner of My Own Advisor. As my own DIY financial advisor, I've surpassed my goal and now investing beyond the 7-figure portfolio to start semi-retirement with. Find out how, what I did, and what you can learn to tailor your own financial independence path. Join the newsletter read by thousands each day, always FREE.
Thanks for the shift+refresh tip RBull. I didn’t know about that. My new keyboard has a refresh button on it and that worked so that I could see your new post without clearing my cache.
Hey, Marko, I just saw your post. You’re welcome. Some browsers work with control+refresh.
Grant/Mark: Thanks for the input.
The other day, Berman (on BNN), talked about ZMI (BMO Monthly Income ETF). I was wondering if that could be a good candidate for an RSP account? Or maybe a mix of ZAG and ZMI? Are they both (relatively) safe in a rising rate environment?
What do you think?
If you want less price fluctuation (but less growth) ZAG would serve that purpose. ZMI is 50% equities, so will be more volatile but have greater expected return, so it really depends if you want more stocks or bonds in your RRSP. If you are wanting something to replace maturing bonds, then ZAG would make more sense in that it would be keeping your asset allocation what it is now.
Hey Peter,
My understanding of this fund, ZMI, is because it’s a fund of funds it’s designed to be inside a registered account and replace many existing ETFs or funds to be an all-in-one product. In doing so, based on the assets it holds, it’s also designed to be income-oriented and payout about 4%. So, while you won’t get much growth from this fund (i.e., little price appreciation) you should get steady (but not growing) income.
In terms of being relatively “safe” that’s subjective but what I can say is because 18% of the bonds are short-term (ZCS) and 6% are short-term government bonds (ZSU) then as rates rise, bond prices fall but not as dramatically since the bond terms are generally short. I would need to read the fund prospectus to understand more. I hope that makes some sense.
I wonder how tax efficient ZMI is compared to other ETF wraps?
https://www.bmo.com/gam/ca/advisor/products/etfs?fundUrl=/fundProfile/ZMI!hash!holdings#fundUrl=%2FfundProfile%2FZMI%23holdings
Weird but I haven’t been able to view any ETF info on the BMO site for at least 6 mths now.
Not sure if has to do with my browser or settings etc.
Must be your browser settings RBull as I can view the BMO ETF info.
Funny enough I can’t read the latest blogposts here on myownadvisor unless I clear the cache on my Chrome browser/ OS each day. I just bought a new Google Pixelbook and this is the only site I have problems with.
Yes, I use firefox and if I use edge it works for BMO.
Mark’s site is also the only one I have use shift and refresh for every thread and to update every post. Strange.
Mark, I think there’s some confusion about diversification when it comes to ETFs. An ETF is just a container. It’s what’s in the ETF that matters. For example VGRO, a new Vanguard ETF, contains thousands of stocks and bonds from all over the world, so this one ETF gives you the most diversified portfolio you could get. The Canadian Couch Potato has 3 ETFs which contain more or less the same securities as VGRO, so is equally well diversified. So whether you have 1,3 or 5 or more ETFs isn’t the issue – it’s what’s in the ETFs that we should focus on when determining if we have an adequately diversified portfolio, or not adding cost and complexity unnecessarily by doubling up on some particular assets.
I didn’t mean to create confusion Grant. Not all ETFs are created equal. Rather, some ETFs are outstanding for diversification, just like many mutual funds are.
To your point, the beauty of some wrapped funds is that you get one product that is essentially many products in one – and only one fund you need to manage.
Sorry, I didn’t mean that you were creating confusion – I mean in general there is some confusion out there about this. Yes, it’s the index ETFs that offer great diversification, and all ETFs are certainly not index trackers.
Well said 🙂
Grant – that’s a good explanation of bond fund prices and yields.
Great post Mark!
Upon retiring, my wife and I decided that we could manage our own accounts. Since I have plenty of time, and a bit of knowledge on investing, that’s what I do with 7 accounts: 1 taxable, 2 RSPs, 2 LIFs, 2 TFSAs. The taxable has 30% US stocks. I only have two ETFs, ZWB and ZWU, dripping. I have many bonds and other fixed income, that will come to term this year and in a year or two. My problem is with interest yields so low, I’m not inclined to “go back” to individual fixed income, so I was thinking that the ETF route might be the solution. Yet, they fluctuate and you’re not certain you’ll get your capital back in 5 or 10 years.
Or maybe there are better fixed income ETFs out there that could fit the bill. Can you suggest any that will (should) stand the road for the next 5-10 years?
Thanks and keep up your ideas and tips coming in!
Great to hear from you Peter. Smart of you (in my opinion) to DRIP your ETFs – money that makes money can make more money!
I haven’t been a big fan of bond ETFs for some time now but I can appreciate how they stabilize an investors portfolio.
BMO ZAG is well rated – http://www.moneysense.ca/save/investing/etfs/best-fixed-income-etfs-for-2018/
I’d put fixed income in a mix of an aggregate bond fund like ZAG and a 5 year GIC ladder. More to GICs if you don’t like the fluctuations of bond funds. However, if interest rates do go up the price decline of bond funds is only temporary – the higher coupons of the new bonds bought from old bonds coming due make up for the price drop so you are back it even by the duration of the bond fund, about 6 years for ZAG ans about 3 years for a short term bond fund like VSB. The expected return of VSB is less than ZAG, though.
For the ETF portion of our portfolio we have 5.
1 small position in XRB real return bonds
US > VTI broad mkt & HDV div payers
INT > VXUS broad mkt & IDV div payers
CDN > stocks/reits, corp bonds, GICs, HISA
Seems like a great set-up to me RBull. Well done.
Thank you. So far so good.
For the ETF portion of my portfolio I use Andrew Hallam’s suggestions – this has helped me sleep better!I hold VCN for Canadian exposure, VXC for US and international, and VSB for short term bonds ( and cash). Questrade is great as they charge almost nothing for ETFs.
Well done Karen and certainly nothing wrong with Andrew Hallam’s recommendations. He’s a sharp guy!
VXC is a good U.S. product that is listed in Canada. Hard to go wrong with that for the next 10-20 or even 30 years!
I really don’t have any significant ETF holdings. I use the TD Dow and Euro E-series funds (technically not ETFs) for foreign diversification and orphaned cash. All the other equity is being held as individual stocks. Having said that, I almost consider stocks like BAM.A and PWF to be almost mini mutual funds themselves.
Yes, BAM.A, PWF are conglomerates for sure. TD e-funds are good products as well. Not ETFs, true, but good low-cost funds.
We don’t have a lot in the e-funds (85K over all the accounts mostly the Dow) but they work well for us and we’re happy with them.
And just for giggles I calculated the breakdown of the accounts…DW’s RRSP is 60% equities, 40% GIC ladder. My RRSP/LIRSP is 71% equities, 29% GIC ladder/debentures. Both TFSAs are 100% equities. We are also sitting on a large cash wedge (175K) that I don’t know exactly what I’m going to do with yet (car going in for servicing on Tuesday and if the mechanic says it’s unsafe that will need to be replaced, new roof on rental is likely in the near future and a remodeling of our house is a strong possibility)
You are doing extremely well. Do not know how to spend a big amount of money is a super good problem to have. Normally we worry about where to find the money that we need to spend.
I use e-funds in resp accounts.
We’ve done well financially. A large part of the cash was recently added from our daughter’s estate. Just not sure exactly what to do with it.
You’re very smart to have a healthy cash wedge in retirement Lloyd.
I/we hope to have 1-year or so of expenses (say $50k always in cash) plus the steady dividend income (of at least $30k per year that I write about), plus RRSP withdrawals up to another $20-30k per year. Small pensions on top of that in our 60s and 70s and beyond (another $25k+ per year) should be enough for us – I will appreciate the fixed income as I get older!
“You’re very smart to have a healthy cash wedge”
LOL…It’s just laziness and procrastination as I never intended this to happen. Our income stream (pensions and disability income replacement) exceeds our expenses for now and for the next 8 years so we don’t really need a large cash wedge.
“Our income stream (pensions and disability income replacement) exceeds our expenses for now…”
Exactly where my wife and I want to be; i.e., income > expenses in our 50s. Time will tell 🙂
Hats off Lloyd. Nicely done.
We’re more geographically diversified equity wise, and less equity exposure overall. I have way too much cash looking for a home myself.
I had thought about/seriously considered more geographical diversification over the years but just never got around to it. We’re not adding to any of the retirement plans and they just DRIP by themselves. I’ve been adding to the Dow and Euro e-funds in the TFSA cause it’s easy and I’m lazy so I think I’ll just keep doing what I’m doing.
If it works for you meeting your needs and you sleep at night keep doing it. In any case who knows what will work out best?
I love ETF’s and don’t mind paying the nominal fees given the diversity and simplicity they offer. While I have up to 5 ETF’s in some of my accounts my wife’s accounts all have only 3 – iShares XDIV and XDG for equity as well as BMO ZAG for bonds.
I also really like the one fund Vanguard ETF’s – https://www.vanguardcanada.ca/individual/etfs/about-our-asset-allocation-etfs.htm?
Yes, I want to offer a post about my take re: Vanguard all-in-one funds. They have merit for sure.
The compounded cost of ETFs over time can make a difference, but sometimes their ease of use and diversification into international markets is worth it. I have found them useful for my bond funds which pay monthly.
Fair point Paul. I know of many investors that like bond ETFs for the simplicity.
I hold TPE and VFV in my RRSP for Int’l diversification. My wife’s RRSP is Couch Potato + ZPR (4 ETFs).
I think that seems reasonable (4 ETFs).
You could also ask how many mutual funds a person should own. Although mutual funds aren’t really my thing, I’ve held 4 for about 10 years in a LIRA. In my company’s group retirement plan I hold 3 mutual funds loosely following the Couch Potato allotment. In December I plan to transfer them to my Questrade RRSP account and put into an ETF. I have a small amount in an RRSP in whatever mutual fund ING’s Streetwise became, and 2 more mutual funds in a non-registered account that I’m probably going to switch to ETFs. I’m not really all that keen on mutual funds.
As for ETFs I have 3 in non-registered, 1 in my RRSP, and 2 in my TFSA and I still don’t think it’s enough. Everything is fairly well diversified. I also hold REITs and a few stocks, not sure if I’d continue to buy more REITs, but in no hurry to sell what I have. I’d probably buy another ETF or 2 that fits my plan instead of buying other stocks. It just seems that ETFs have become a good fit for me. How many ETFs are enough for me? I don’t know that yet.
Well, a LIRA can be a different consideration than an RRSP since it’s technically a pension fund. So, in that respect, a few funds in the RRSP and a few funds in the LIRA can make great sense. It’s not to suggest you have to have only up to about 5 funds but you can also consider your handful of funds spread across your entire portfolio – since it could be considered one big account.
This is where every investor is different. Do you need a few dozen ETFs? Probably not. Is only one, the same one, spread across all account enough? It actually could be since there are funds of funds that can help investors these days. I’ll write about that eventually.
Diversification is a key requirement proposed by almost everyone. Diversify into all sectors, all markets, all everything? I could never figure that out and in our case we made more mistakes by trying to diversify, especially into cyclical sectors and foreign markets.
Thankfully we changed to Concentration rather than diversification, its worked for us.
You’ve done very well with a concentration of CDN stocks, which is excellent since you have met your goals this way, but I suspect you’re somewhat rare in that regard!
Cannew, investors diversify to give themselves the best chance of the optimal outcome because the future is not predictable. Now, you have done very well with a concentrated portfolio of Canadian stocks, and more power to you for that success. But if you had been living in Japan? Not so much. It’s important not to confuse strategy with outcome.
That’s well put Grant – “It’s important not to confuse strategy with outcome.”
@Grant: “give themselves the best chance of the optimal outcome”. We’ve discussed this before and I don’t have a problem with those believing Diversification is the best route to success (or preserving their capital). In fact I agree if one sticks to their plan for the Long-Term they will probably be successful (provided they hold for the long-term).
From 2006 we concentrated on Income Generation through the Fin Crisis and recovery. When we started our portfolio was only generating $15k of Income. Today our dividends generate more than two times our annual expenses. When the next crash, recession or correction comes I don’t expect our income to drop, I wonder how the others will do?
Cannew, when the next crash comes, using a total return approach, your income can keep increasing with inflation as you sell appreciated bonds for living expenses, and rebalance buying equities at depressed prices.
If I’m still around when the next one occurs, though the Trade Wars may do it, lets compare notes.
I suspect depressed equity days are ahead…time to save some cash for new purchases!
It’s not true that bonds will always appreciate while equities depreciate. During financial crisis, everything went down, including bonds. It’s true bonds were down less than equities, and it’s OK if you sell for re-balance. But I won’t feel any comfort if I have to sell depreciated assets for my living expense.
If you use a total return approach, I think you need to have a cash wedge covering two years of living expense so that you don’t sell at the market bottom. I don’t think Cannew needs that much cash wedge though.
@Mark Yeah, looks like lots of stormy days ahead.
May, you’re right, bonds will not always go up when stocks go down, but it’s very rare for both stocks and bonds to go down together on an annual basis. In fact, it’s only happened 3 times since 1926, and 2008 was not one of them – 1931, 1941 and 1969. So it’s a good idea to have a couple of years in cash, or use a GIC ladder with a year’s expenses in each rung as part of your bond allocation, to use during those times.
@Grant: Yes Japan has seen 15 years or so stagnation and ones portfolio would not have grow in value. But if one owned Japanese stocks which paid growing dividends and I’m sure there are some, would one have not seen a growing income?
The Japanese stock market is about half what it was 18 years ago. Not to mention that total return is what really matters for wealth accumulation, I’m sure there would be few, if any, stocks that would have paid growing dividends over 18 years when the market is down 50%.
I would have not wanted to invest in Japan for the last 20+ years. Hindsight is 20-20, which is why investors tend to diversify. I intend to own some VXC or XAW in my RRSP, eventually, since I want to reduce my CDN stock bias AND I don’t want to deal with currency conversion costs.
Thoughts on that Grant? I suspect you would support!
Grant, I agree that Japan is a scary example for what could happen for investors in one individual country. And Japan is ~8% of world economy.
Mark, with something like VT vs. VXC you could do a lot of currency conversions over the years for the savings in MER- .10 vs .27. ie $100K = $100 vs $270 or let that $170 difference grow for you. Although it holds about 3% CDN equity. To me the CDN equivalents aren’t yet (and probably will never be) competitive enough, although if smaller amounts invested and/or convenience desired then I can understand VXC.
You know my thoughts on diversifying globally!
At some point probably soon your institution will also make conversions easier for you to do.
Fair point but I think until I have ~ $25k or so in VXC, or XAW, if I go that route, it doesn’t make too much sense to go with VT or VXUS or VTI. I’m really not saving that much. Besides, I own a healthy amount of VYM that is about 6% of my entire portfolio – one of my largest individual holdings in fact.
I would agree given the withholding taxes drag, CDN listed ETFs that hold U.S. and international funds will never be as competitive as U.S.-listed ones.
Mark, yes, I agree VXC or XAW is great way to diversify out of Canada. I wouldn’t have more than about 30% of equities in Canada.
RBull, excellent point about using VT instead of VXC. Another advantage is that if it’s held in an RRSP, you won’t lose the foreign dividend withholding tax as you would with VXC.
Yes, the challenge with VT, and VXUS, etc. is that they are U.S. listed ETFs and therefore you need USD $$ to buy and hold them. With XAW or VXC I don’t have to worry about currency conversions but yes, there is trade-off; higher costs to own XAW and VXC with the foreign withholding taxes.
Wild eh? VT has 8,000+ stocks and MER of 0.10%. Cheap and one of the best, diversified funds you can own.
Grant, good point on the foreign div. withholding tax, which helped form part of my personal choices.
Yeah, like I mentioned in my post I agree with you Mark on the investment amount being a factor in choosing currency for a global ETF. I probably wouldn’t bother unless I was investing 50K or more, and not dealing with ongoing smaller regular contributions.
Makes sense. There is definitely a cut-over point whereby US listed assets make more sense than CDN listed assets.