When you purchase a mutual fund or ETF you are buying a share of a pool of specific assets that might include stocks and bonds in a variety of sectors and countries. An index mutual fund or ETF portfolio can give you all the diversification you need in as little as one to four core funds covering your major asset classes.

However, many investors, not satisfied with a minimum number of funds, start adding more and more to their portfolio – dividend stocks, REITs, value stocks, small cap, large cap – thinking they are increasing their diversification.

Related: Why indexers are terrible at indexing

Do you hold too few eggs in your basket?

How can you tell if your portfolio is properly diversified? Proper diversification maximizes your profits while minimizing risks. A Canadian equity fund may have good diversification in the Canadian equity market, but if you start adding variations of Canadian equities you might find you are duplicating your holdings.

For example, say you hold Vanguard FTSE Canada All Cap ETF and then decide to “diversify” with dividend paying stocks and purchase iShares Canadian Select Dividend Index ETF. By drilling down to the fund holdings, you find that you are doubling your holdings of certain stocks that are common to each fund.

In this example, half of the funds top holdings are duplicated. If instead you bought iShares Core S&P/TSX 60 Index ETF, you would find nine of the top ten holdings duplicated.

Related: Is my two-ETF portfolio too simple?

Not only are you paying twice for the same holdings through the funds MERs, you are increasing your risk profile by having too much exposure to a smaller handful of stocks. (In the example above, Canadian banks would make up almost half of your portfolio.)

Final thoughts

Take a look at the composition of your funds, especially if you also hold individual stocks. If you decide to purchase another fund, compare the holdings to avoid falling into the under diversification trap.

If you find you have too much concentration in one area, search for funds that aren’t as closely correlated. But, be careful not to go to the other extreme of over-diversification, which can increase costs and ultimately dilute overall returns.

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5 Comments

  1. Hysljo on February 3, 2016 at 8:12 am

    I don’t understand, or agree with, your comment of “not only are you paying twice for the same holdings through the fund MER’s”. The amount you’re paying in MER’s is the same, whether you hold one or two ETF’s. For example, let’s assume you put $100 in two ETF’s and each ETF has an MER of 1%. In this case, you would pay $1 in MER for the first ETF and another $1 in MER for the second ETF, for a total of $2. Conversely, if you had bought just one ETF for a total of $200 and an MER of 1%, your total MER would be $2. Owning two ETF’s does not double your MER payments if the total amount invested is the same.

  2. Tyler on February 3, 2016 at 9:10 am

    Great point about diversification. Love the “diworsify” play on words!

    Not to be picky, but I think the statement below is a little misleading:
    “Not only are you paying twice for the same holdings through the funds MERs…”

    MER’s are calculated as a percentage of the funds value in your portfolio. So while you would be paying twice (as in paying MER fees in two transactions, one per fund) you wouldn’t be paying “double” the amount in MER fees. As a percentage, it would remain the same (assuming MERs are equivalent among both funds).

    However, I would agree that you would be paying twice the trading costs in the case of ETF, since you are buying/selling the same stock in two different places.

    • boomer on February 3, 2016 at 1:35 pm

      @Tyler. Yes, technically you are correct about the fees. But, (let’s see if I can explain what I mean) let’s say you have a Canadian equity fund and you want to diversify by buying what you think is a different type of fund. If the holdings are the same, you have twice the same holdings (so twice the price) when you think you are paying for something else.

  3. Salim Patel on February 3, 2016 at 1:27 pm

    Is there a site anywhere where one can enter all their holdings ETFs/MFunds/Stocks/Bonds in one and it can tell you how your portfolio looks like? – For example Equities, MFunds, Bonds/Fixed Income etc or even this is the % in Canada, US or North America, Global, Emerging Markets, Developed Market etc

    • Larry on February 6, 2016 at 2:53 am

      You can try morningstar.ca portfolio x-ray.

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