How many ETFs do you need in your portfolio?

February 22, 2024 Rick Maggi

Adam DeSanctis, Vanguard’s Head of ETF Capital Markets in Australia, explains how to build an ETFs portfolio and mistakes to avoid.

Exchange traded funds (ETFs) have become the investment vehicle of choice for many Australians.

In fact, according to the ASX Australian Investor Study 2023, one-in-five (20%) of the 7.7 million on-exchange investors in Australia hold one or more ETFs in their investment portfolio. That means more than 1.5 million Australians are now using ETFs.

But how do you build a portfolio out of ETFs, and how many ETFs do you need to do that? That’s a very common question from investors, but first it’s important to understand why ETFs have become so popular.

Q: Adam, why have ETFs become so popular among investors in Australia?

A: The first ETFs were launched in Australia more than 20 years ago and there’s now more than 300 products trading on the Australian Securities Exchange.

Some of the early adopters of ETFs in Australia were financial advisers, and they’re now being readily used by portfolio managers and financial planners.

But we’ve seen huge growth in the ETF industry over recent years as more and more mum and dad retail investors have discovered them and the significant investment benefits they can provide.

In fact, over the last 10 years the amount of money invested in ETFs in Australia has increased close to 20-fold to almost $180 billion.

There are a range of reasons behind this phenomenal growth. They include their easy access, low entry and management costs, inherent diversification, and trading flexibility.

Q: So, what should investors understand before building a portfolio using ETFs?

A: To build a sound investment portfolio, whether it be with ETFs or any other types of securities, investors should really ask themselves, “Why I am investing?”. Is it a long-term strategy for retirement, or is it for shorter-term purposes such as a child’s education or for a holiday?

Another consideration could be income generation in retirement, keeping in mind that the dividend and income distributions paid to ETFs from their investment holdings are ultimately all passed through as distributions to ETF unitholders.

Having a firm understanding of your investment goals will help you pin down your time horizon and how much risk you’re willing to take to achieve those goals.

These are key questions to answer before you start the building process.

Q: Many investors hold more than one ETF in their portfolio. How many ETFs should investors have in their portfolio? Is there an ideal number?

A: Having more is not always better when it comes to building a portfolio using ETFs. What you should really be striving for is a well-diversified portfolio. Diversification is not necessarily about owning more securities, but rather the right mix of securities.

Investing in several bank shares instead of just one may help offset the risk of investing in one company, but then you have concentration risk because you’re heavily invested in the same industry. Similarly, investing solely in Australian companies increases diversification across sectors, but you remain concentrated in the local market.

Index-tracking ETFs investing in a wide range of companies are ideal as core investments in a portfolio. One ETF can hold investments in hundreds, and sometimes thousands, of different companies. For example, the largest ETF on the ASX is the Vanguard Australian Shares Index ETF (VAS), which tracks the return of the S&P/ASX300.

Investing in VAS is the same as investing in the top 300 companies on the ASX, but instead of purchasing individual shares from each of the 300 companies, VAS combines them all into the one fund according to their market size.

You can also invest in other ETFs that provide broad exposure to international markets.

So, with just a handful of ETFs, it’s possible to diversify not just across sectors but also regions and asset classes.

Q: What mistakes do you see investors make when building ETF portfolios?

A: One mistake is having a portfolio with too many niche ETF products, and another is holding too many ETFs that have overlapping investments.

Some investors build their portfolios from the bottom-up, focusing on each investment holding rather than the portfolio as a whole. They often lack the diversification needed to adequately mitigate market risks. One example could be an investor that uses thematic ETF products that aim to capture specific growth trends such as AI computing or cryptocurrency, instead of using a broadly diversified index fund as their core holding.

As for the second mistake, there is such a thing as too much of a good thing. Holding several ETFs that overlap might sound like a great case for diversification, but you’re essentially paying twice or thrice the costs for the same or very similar thing. And your portfolio is likely to experience more volatility than a broadly diversified one. So it’s very important to look at the underlying companies that ETFs are investing in so you can determine if there are overlapping investments.

Q: Is it enough to just buy ETFs that track the broad Australian and U.S. equity markets and then call it a day? What are you missing by doing something like that?

A: It's really an individual investment choice. Having exposure to the Australian equity market through an ETF that invests in the biggest companies is obviously important for many investors based on the large monthly inflows we see into the VAS product. So does investing in international markets, again based on the inflows we see into our international equity ETFs. But there are a wide range of ETF investment options available, including high-quality fixed income (bond) ETFs that can help to reduce portfolio volatility.

There are also multi-asset (diversified) ETFs, which are basically ready-made portfolios that can be an incredibly effective way to achieve diversification and would be a great option for most investors. So, it is absolutely possible to build an entire portfolio using just a single ETF. It comes down to personal choice.

Investors who feel they need guidance in how to build an ETF portfolio should consider engaging with a licensed financial adviser.

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Important Information

Vanguard Investments Australia Ltd (ABN 72 072 881 086 / AFS Licence 227263) (“Vanguard”) is the issuer of the Vanguard® Australian ETFs. Vanguard ETFs will only be issued to Authorised Participants. That is, persons who have entered into an Authorised Participant Agreement with Vanguard (“Eligible Investors”). Retail investors can transact in Vanguard ETFs through Vanguard Personal Investor, a stockbroker or financial adviser on the secondary market.

We have not taken your objectives, financial situation or needs into account when preparing this publication so it may not be applicable to the particular situation you are considering. You should consider your objectives, financial situation or needs, and the disclosure documents for Vanguard’s products before making any investment decision. Before you make any financial decision regarding Vanguard’s products you should seek professional advice from a suitably qualified adviser. . The Target Market Determination (TMD) for Vanguard’s ETFs include a description of who the ETF is appropriate for. You can access our IDPS Guide, PDSs Prospectus and TMD at vanguard.com.au or by calling 1300 655 101.