"To err is human," they say, and that includes having a portfolio stuffed with random ETFs that weren't exactly part of your original plan...
Do not worry, you are not alone! Everybody does it. We’ve all bought a fund or three on impulse. Maybe it was an investment that was on a roll, or tracked a sector we got excited about. Perhaps we were reacting to world events, or got FOMO (= Fear of missing out) after hearing about a major tech breakthrough.
Now we’ve got 0.63% of our asset allocation in Japanese Small Caps, or 2.462% in an Esports ETF. It happens.
And sure, it makes us feel a little bad. Because we’re not the perfect investor and haven’t stuck precisely to the plan.
It’s a bit like the feeling you get when you walk into the messiest room in the house. The one that’s chock full of guilty purchases and possessions that are past their prime. It’s a tip, but you can’t quite bear to part with your stuff just yet.
But should you really be sorry? Sometimes being able to store things in that messy room is what allows you to keep the rest of the house running smoothly. It’s the same with your portfolio … Like all things in life, it’s a question of balance.
When to take action
As long as you have a plan and are mostly on course, then it’s OK to drift a little at the margin.
Many wealth managers say it’s fine to have 5% of your portfolio in more speculative investments – the ones that let you have fun or experiment. Think of that as your wiggle room. Or the grey zone that’s neither good nor bad.
But you’ll know things are out of control when:
You can’t bear to look at your portfolio because it feels too overwhelming.
You look at it and don’t understand it.
You're investing randomly into a hodgepodge of ETFs without a proper strategy.
The complexity stops you employing basic portfolio hygiene techniques like rebalancing.
Most of your ETFs weigh less than 5% of your total asset allocation. Any individual fund that’s below the 5% level won’t make much difference to your returns.
Its probably a bad sign if your ETFs number in double figures, and their holdings overlap, or you can’t remember what each fund is .
If this sounds like you, then it’s time to simplify.
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Remember we can live with a few surplus ETFs that you don’t want to put more money into but don’t want to sell either.
But while diversification is a fundamental principle of investing, you can go too far.
You may wince at the thought of dealing with it but don’t forget there’s always a wonderful glow of satisfaction to be had when you finally take charge of a situation that’s been bothering you.
At this point, it’s worth recalling the old investing adage which advises us to sell any investment that we wouldn’t buy more of today.
The underlying wisdom is that, if you’re not confident enough to commit more funds to a position, then you should sell it and put the money into something you do believe in.
You can combine this idea with the rule-of-thumb that any ETF worth less than 5% of your total portfolio is making a negligible difference to your results anyway.
Even if that ETF soars in the future, it just won’t move the dial much when it only amounts to a small sliver of your net worth.
So there’s no need to regret pruning back tiny positions. You’ve got little to lose and plenty to gain by ploughing the cash back into stronger holdings.
Check for ETFs with a high degree of overlap
Another tip is to check for ETFs with a high degree of overlap.
For example, there’s little point holding a few per cent in a tech stock ETF if you also own a S&P500 ETF, or even a World ETF. Both of those hold plenty of tech stocks, so you’ll still benefit when giants like Apple and Amazon outperform.
Remember that most equity markets are highly correlated too. They’ll tend to move up and down in sync so you can happily jettison minor holdings knowing that you’ll capture most of the benefit from a booming economy in a plain World ETF.
Moreover, individual sectors, industries, and countries are typically more risky than holding the entire world because they’re less diversified. Guard against over-concentration in volatile sub-asset classes like these.
When reviewing your ETFs, always take time to check their costs using the TER metric on justETF.
Performance cannot be guaranteed whereas costs are certain, so you can happily chop high cost ETFs which don’t have a meaningful role in your portfolio. High expense ratios can eat into your investment returns over time, so err in favour of lower cost alternatives.
Check ETF returns
Another trick is to go back through your ETFs and check their returns versus a World ETF using justETF’s chart functionality. How many have actually added value versus that super-diversified World ETF?
Now you may well be reluctant to sell losers and lock-in losses. That’s OK because the past cannot be relied upon as a guide to future performance.
However, even if you can’t cut existing holdings, at least this process may curb the urge to buy additional ETFs in the future, especially if it’s just because they’ve been on a hot streak.
Remember that assets often fall back after hitting highs – an effect known as reversion to the mean. So it’s typically better to buy in using cost averaging – a technique that enables you to gain more ETF shares for less by buying them regularly and when on sale.
That said, if your ETF shopping problem is due to a lack of a clear investment strategy then spend some time nailing that down first. Establishing your strategy will enable you to think about how each of your ETFs fits into your overall portfolio. Our ETF Portfolio Strategies section in our Academy will get you started.
Remember, the ultimate goal is to build a well-diversified and manageable portfolio that aligns with your investment objectives. By following these tips, you can streamline your portfolio, reduce complexity, trim costs, and control your risks.
Just don’t beat yourself up for not being perfect. Nobody can be an angel all the time.
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