Etfs: Smart Single Investment Or Risky Business?

Exchange-traded funds (ETFs) are baskets of individual securities, much like mutual funds but with two key differences. Firstly, ETFs are traded on exchanges like stocks, while mutual fund transactions occur only when the market closes for the day. Secondly, ETFs have lower expense ratios. While a single top-tier ETF may be enough for some investors, others may benefit from holding multiple ETFs to achieve greater diversification. The right combination of ETFs can produce a balanced, diversified portfolio.

Simplicity and reduced costs

The main benefit of investing in a single ETF is simplicity. Investing in a single ETF is a straightforward strategy that can be more manageable than investing in multiple ETFs or individual stocks. With a single ETF, there is less to monitor and track, and you avoid the complexity of managing multiple funds or stocks. This simplicity can be especially beneficial for new or busy investors who may not have the time or expertise to actively manage a complex portfolio.

Additionally, a single ETF can provide adequate diversification, reducing risk by spreading your investment across a variety of stocks or assets. For example, the Vanguard Conservative ETF Portfolio (VCNS) provides exposure to over 18,000 individual bonds and 13,000 individual stocks from around the world, offering extensive diversification in a single fund.

Another advantage of investing in a single ETF is reduced costs. ETFs generally have lower expense ratios compared to mutual funds, and this benefit is amplified when investing in a single ETF. By consolidating your investments into one fund, you avoid paying multiple expense ratios and transaction costs, which can add up over time.

However, it is important to note that investing in a single ETF may not provide the same level of diversification as a carefully curated portfolio of multiple ETFs or individual stocks. The level of diversification depends on the specific ETF and its holdings. Therefore, it is crucial to research and understand the composition of the ETF to ensure it aligns with your investment goals and risk tolerance.

Additionally, while a single ETF can provide a simple and cost-effective solution, it may not offer the same level of flexibility as a more diverse portfolio. With a single ETF, you may have limited control over your asset allocation, as the fund determines the weightings of different sectors or asset classes.

In conclusion, investing in a single ETF can offer simplicity and reduced costs, making it an attractive option for investors seeking a straightforward and cost-effective investment strategy. However, it is important to carefully select an ETF that aligns with your investment goals and provides adequate diversification to meet your risk tolerance.

Diversification

ETFs are baskets of individual securities, and by investing in multiple ETFs, you can achieve greater diversification across different sectors, strategies, and asset classes. This diversification can be beneficial during bear markets, as a well-diversified portfolio may provide more security and potentially higher returns.

When considering diversification, it is important to look beyond the number of holdings within an ETF. For instance, an ETF may have a large number of holdings but lack exposure to certain sectors or markets. Therefore, it is crucial to analyze the top holdings, sectors, and individual stocks within an ETF to understand its true diversification.

Additionally, investors should be cautious about overlapping holdings across multiple ETFs. While diversification is important, investing in multiple ETFs with similar top holdings may not provide the desired level of diversification. Tools are available to compare the overlap between different ETFs to make informed decisions.

For investors seeking a simple and well-diversified portfolio, a single ETF may be sufficient. All-in-one ETFs, such as Vanguard's asset allocation ETFs, provide exposure to multiple asset classes, sectors, and markets through a single product. These funds are designed to be well-diversified and automatically rebalanced, making them a low-maintenance option for investors.

However, there are benefits to holding multiple ETFs or combining ETFs with individual stocks. By doing so, investors can have more control over their asset allocation and can tailor their portfolio to their specific goals and risk tolerance. This approach may be more suitable for experienced investors who are comfortable conducting in-depth research and actively managing their investments.

In conclusion, when considering whether to invest in one or multiple ETFs, the key is to assess your investment goals, risk tolerance, and desired level of diversification. While a single well-diversified ETF can be a simple and effective option, combining multiple ETFs or adding individual stocks can provide greater flexibility and control over your portfolio.

Historical returns

The Vanguard Growth Index Fund ETF (VUG), for example, has generated steady and impressive returns over the long term. With an annualised return of 16.27% over the past 15 years and 17.37% over the last five years, VUG has outperformed most other ETFs and the returns offered by banks. This highlights the potential for an ETF with strong historical returns to be a valuable addition to a portfolio.

However, it is important to note that not all ETFs with good historical returns will continue to perform well. The ARK Innovation ETF, for instance, has experienced peaks and valleys in its returns. Therefore, it is crucial to conduct thorough research and due diligence before investing in any ETF, considering factors such as the fund's holdings, expense ratios, and overall portfolio diversification.

Additionally, it is worth mentioning that while ETFs offer instant portfolio diversification, some funds may be overly focused on a specific sector. For example, the SOXX ETF, a top-performing fund, has all its holdings in the semiconductor industry. As a result, investors should carefully evaluate the diversification provided by an ETF before relying on a single fund for their investments.

In conclusion, when considering investing in just one ETF, it is essential to examine its historical returns and compare them with other top-performing funds. While strong historical returns do not guarantee future performance, they can provide valuable insights into the consistency and potential of an ETF. However, investors should also be cautious and consider other factors to make a well-informed investment decision.

Growth focus

If you are a young investor with a lengthy time horizon, you may not need to diversify your portfolio with multiple ETFs. A single top-tier ETF with a growth focus can be a good strategy to pursue your financial goals. Here are some reasons why investing in one growth-focused ETF might be a suitable approach:

Diversification:

Investing in a well-diversified ETF like the Vanguard Growth Index Fund (VUG) can provide exposure to a large number of stocks across various sectors. VUG, for example, offers a mix of technology and other sectors, giving you instant diversification with a single investment.

Historical Returns:

When considering a growth-focused ETF, look at its historical returns to gauge consistency. VUG, for instance, has generated steady and impressive returns over the long term, with an annualized return of 16.27% over the past 15 years.

Growth Potential:

As a young investor, you may not need dividend income right away. Focusing on a growth ETF can be a strategic choice, as dividend income can hinder total returns due to taxation and the fact that corporations may not reinvest those dividends for growth.

Simplicity:

Investing in a single growth-focused ETF keeps your portfolio simple and easy to manage. You avoid the complexity of monitoring and rebalancing multiple ETFs, allowing you to focus on your long-term growth objectives.

Similar Portfolios:

Many growth-focused ETFs have similar portfolios, with the same top holdings. For example, VUG, SPY, and QQQ have the same top five holdings. Therefore, investing in multiple growth ETFs may not provide significant additional diversification.

Career Growth:

Instead of chasing high-risk investment opportunities, focus on growing your career and income. Increasing your monthly contributions to your portfolio can make you less susceptible to the lure of risky investments. Growing your income may be more valuable than chasing short-term returns.

Remember, while a single growth-focused ETF can be a solid strategy, it's important to assess your risk tolerance and conduct thorough research before investing. Additionally, consider seeking advice from a financial advisor to ensure your investment strategy aligns with your specific circumstances and goals.

Individual stocks

While investing in a single ETF can be a good strategy, it is worth considering investing in individual stocks as well. Here are some reasons why:

Diversification: While a single ETF can provide diversification across various sectors and industries, investing in individual stocks allows you to further diversify your portfolio. By choosing stocks from different sectors and industries, you can reduce the risk associated with putting all your eggs in one basket. This strategy can be especially beneficial during bear markets or economic downturns, as it provides a safety net and potentially lowers your losses.

Customisation: Individual stocks allow you to customise your portfolio according to your specific interests, goals, and risk appetite. For example, if you believe in the potential of a particular industry, such as cloud computing or chipmakers, you can allocate more resources to those sectors. This level of customisation is not possible with a single ETF, which may have a predetermined allocation strategy.

Active investing: Investing in individual stocks requires active research and monitoring. If you enjoy the process of researching and analysing stocks, this approach can be rewarding. It allows you to make informed decisions about which stocks to buy, sell, or hold, giving you a sense of control over your investments.

Potential for higher returns: By carefully selecting individual stocks, you may be able to achieve higher returns than with a single ETF. Certain stocks may outperform the market or specific sectors, providing you with greater profits. However, it is important to remember that higher returns also come with higher risks.

Tax efficiency: For experienced DIY investors, individual stocks offer the advantage of tax efficiency. You can allocate different types of assets to different accounts to optimise your tax strategy. For example, you may choose to hold equities in your TFSA and bonds in your RRIF, which is not possible with a single balanced ETF.

In conclusion, while investing in a single ETF can be a convenient and well-diversified strategy, adding individual stocks to your portfolio can provide further benefits in terms of diversification, customisation, active investing, potential returns, and tax efficiency. However, it is important to carefully consider your risk tolerance, conduct thorough research, and seek professional advice when necessary.

Frequently asked questions