As a long-term investor, you may have chosen exchange-traded funds (ETFs) for their simplicity and potential to diversify your portfolio. It can be a smart approach – one that resonates with many in the Pearler community . But as your investments grow, it’s natural to start thinking about how well they’re working together.
One thing to watch out for is whether your ETFs are overlapping more than you realise. Overlap can sneak up on you, making your portfolio less diversified than you intended.
In this article, we’ll explore how you can keep an eye on your ETFs to make sure they’re complementing each other. The goal is to help you stay on track with your long-term investing strategy, with a portfolio that truly works for you.
What is asset overlap?
Asset overlap happens when you hold multiple ETFs that include the same investments. This means that the same company, sector, or region appears in more than one of your ETFs. It might not seem like a big deal at first, but over time, it can impact your ETF returns .
For example, if two of your ETFs invest heavily in the same company or sector, you could end up with a larger portion of your portfolio tied to that single investment. This can affect how balanced your portfolio is and how it responds to changes in the market.
Understanding asset overlap helps you see where your investments might be doubling up. By monitoring this, you can keep your portfolio as diversified as you intended.
Why is asset overlap an issue for diversified investing?
The role of diversification
Diversification is one of the main reasons investors choose ETFs. By spreading your investments across different assets, you can potentially reduce risk and smooth out returns over time. For example, if you invest in an ETF that includes 50 different companies, you’re not relying on the success of just one or two companies. If one company doesn’t perform well, the others can help balance it out.
Let’s say you have two ETFs. One focuses on Australian companies, and the other on international companies. By holding both, you’re diversifying across regions. This can help protect your portfolio from being too exposed to a single market.
The issue with overlap
Asset overlap can reduce the diversification you’re aiming for. Let’s assume both of your ETFs hold shares in a major Australian bank. Even though one ETF is international, it includes Australian companies, and this bank is a significant part of both ETFs. This is asset overlap.
With overlap, you end up more invested in that single interest (in this case study, a bank) than you might want. If the bank performs poorly, it could have a bigger impact on your portfolio than expected. This reduces the benefit of diversification because your investments are not as spread out as you thought.
By being aware of overlap, you can build a portfolio with complementary ETFs and create effective diversification. This can help keep your portfolio more balanced and aligned with your long-term goals.
How can I avoid asset overlap in my ETFs?
Avoiding asset overlap can assist in maintaining a well diversified portfolio . Here are some practical steps to consider. Keep in mind, though, these ideas are general in nature. For a personalised guide, speak with a financial adviser.
1. Review ETF holdings
Before investing, check the top holdings of each ETF. Most ETF providers, and brokers (like Pearler ), list these on their websites. ETF providers often publish detailed information about their funds, including the full list of holdings. For example, you might be considering investing in two ETFs – one that tracks the ASX 200 and another that focuses on high-dividend Australian shares. Check if both ETFs hold large amounts of the same companies. If you find that both ETFs include a major bank like Commonwealth Bank, this could lead to overlap.
2. Diversify by asset class
Consider spreading your investments across different asset classes like shares, bonds, or real estate. For example, if you already own a share-based ETF , you might look at adding a bond ETF . Bonds typically don’t overlap with shares, so this can help diversify your portfolio. Real estate investment trusts (REITs) are another asset class that can provide exposure to property, which can further reduce overlap.
3. Choose broad-market ETFs
Broad-market ETFs cover a wide range of companies across different sectors. For example, an ETF that tracks the S&P 500 gives you exposure to 500 large companies in the US across various industries. This can reduce the need to hold multiple ETFs and potentially lower the risk of overlap. In contrast, holding both a broad-market ETF and several sector-specific ETFs, like a technology focused ETF, could lead to overlap if the broad-market ETF already includes many tech companies.
4. Be mindful of sector-specific ETFs
Sector-specific ETFs focus on a particular industry, like technology or healthcare. If you’re interested in a sector-specific ETF, compare its holdings with any broad-market ETFs you own. For instance, you might have a global equity ETF and are considering also investing in a technology ETF. You can check if major tech companies like Apple or Microsoft are significant holdings in both. This can help you avoid doubling up on the same companies.
5. Invest in a diversified ETF
One way to minimise asset overlap is by investing in one diversified ETF . A diversified ETF spreads your investment across many different companies and sectors, all within a single fund. This can simplify your portfolio and reduce the need for multiple ETFs, which might otherwise lead to overlap. For example, a global equity ETF might include companies from various industries around the world.
6. Regularly review your portfolio
Over time, new ETFs might become available, or your investment goals may change. Review your portfolio regularly to help ensure your ETFs continue to provide diversification. For example, if you notice that one sector is becoming too dominant in your portfolio, you might adjust your holdings to restore balance.
7. Use tools to help you
Monitoring asset overlap can be made easier with the right tools and resources. Many online portfolio trackers allow you to upload your ETF holdings to analyse overlap before you invest. These tools can highlight common assets across your ETFs, giving you a clear view of your portfolio’s concentration.
These steps can help you manage asset overlap and keep your portfolio aligned with your long-term investing strategy. They’re a few simple ways to ensure that your investments work together to provide useful diversification.
What else should I consider?
When managing asset overlap, it’s important to keep a few other factors in mind:
Understand your investment goals
Your investment goals should guide your ETF choices. If your goal is steady growth over time, you might prefer ETFs that provide broad exposure across different sectors and regions. If you’re focused on income, you may lean towards ETFs that offer higher dividends . Knowing your goals helps you choose ETFs that complement each other without unnecessary overlap.
Be aware of tax implications
Selling overlapping ETFs to reduce concentration might have tax consequences. In Australia, capital gains tax could apply if you sell an ETF for more than you paid for it. Consider these potential costs when making changes to your portfolio. You might choose to gradually adjust your holdings to minimise tax impacts.
Consider the role of professional advice
If you’re unsure about how to manage overlap or align your investments with your goals, financial advice can be helpful. Financial advisers can give you tailored insights based on your specific situation and help you make informed decisions. This is especially useful if your portfolio has become more complex over time.
Stay informed and flexible
The investment landscape can change, and so can your financial goals. Staying informed about new ETFs and regularly reassessing your portfolio can help you adapt to these changes. Flexibility allows you to adjust your strategy as needed to maintain the diversification you’re aiming for.
Your next move – review and refine
As a long-term investor, you want your portfolio to reflect your goals and work efficiently for you. Taking the time to understand and manage asset overlap is one way to ensure that. It’s not about making drastic changes but about staying mindful of how your ETFs fit together.
Take a moment to review your current holdings. Are they working together as you intended? If you find any asset overlap, consider whether adjustments are needed to better align with your goals. Investing is a journey, and making small, thoughtful changes can help you stay on the right path.
