Investors are always being told to diversify. But what exactly does that mean? A knowledgeable financial adviser can put together a well-diversified portfolio, tailored to the client’s needs. But if you want to do it yourself, it can be a challenge.
I recently received a question from a reader who asked: “How many ETFs would you suggest in a buy and hold portfolio with a term of 7-10 years?” Another reader wrote to say his RRIF portfolio holds 160 stocks and 25 mutual funds. “I feel that this could be classified as diworsification as opposed to diversification,” he said.
There’s no simple answer to these questions. It depends how much diversification you want (although 160 stocks plus the funds is overdoing it) and the amount of risk you’re prepared to accept.
If you want an all-stock portfolio, you could theoretically limit yourself to a single ETF that invests in markets around the globe. One example is the BMO MSCI All Country World High Quality Index ETF. (How’s that for a mouthful?) It trades on the TSX under the symbol ZGQ.
The managers screen global markets for stocks that have a high return on equity, stable year-over-year earnings growth and low financial leverage.
The portfolio holds 458 stocks. You’d think that would provide plenty of room for diversification, but in fact 75 per cent of the assets are in U.S. securities. The top five are all technology companies: Microsoft, Apple, Nvidia, Meta Platforms and Alphabet. Together, those five make up a quarter of the portfolio.
The second largest geographic holding is Taiwan at 3.69 per cent. Canada isn’t even on the chart.
This doesn’t mean it’s a bad fund. In fact, the returns have been good. As of the end of April, this ETF had posted an average annual compound rate of return of 12.38 per cent since its inception in November, 2014. It’s been profitable in every year but one (2022) since its launch. Clearly, it’s a decent place to invest some money. But it is not my idea of a well-diversified global portfolio.
Other companies offer global funds, sometimes excluding Canada. An example is the iShares Core MSCI All Country World Ex Canada ETF (XAW-T). It’s a fund of funds that has better geographic balance than the BMO entry, but its track record is unimpressive.
The bottom line is that I couldn’t find a single fund that would do the job. I suggest a portfolio needs a minimum of three. One should track the TSX Composite (our home market). The other two should cover the S&P 500 and EAFE (Europe, Australasia and the Far East). The allocation depends on how much exposure you want to each market. I suggest investing 50 per cent in the S&P 500 and 25 per cent in the other two.
If you want more stock diversification, consider adding an emerging markets fund and a small-cap ETF such as the iShares U.S. Small Cap Index ETF (XSU-T).
Including one or two bond ETFs would reduce overall risk by adding a fixed-income dimension to the portfolio. Most major ETF companies have one that covers the broad Canadian market, and there are many that track U.S. bonds.
In sum, there is no magic number of securities that would offer a proper asset mix. But if you’re building an all-ETF or mutual-funds portfolio, I suggest 10 holdings at most. For a stock portfolio, you shouldn’t need more than 25 to 30 positions.
Gordon Pape is the editor and publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca/subscribe
Gordon Pape