Exchange-traded funds (ETFs) are great for quickly diversifying your portfolio, but owning multiple ETFs can sometimes lead to unintended consequences, such as overlapping holdings.
🧠 What you need to know
ETF overlap occurs when multiple ETFs in your portfolio hold the same stocks. This can unintentionally increase your concentration in certain stocks, heightening exposure to specific risks, particularly if those stocks are volatile or if the sector faces downturns.
For example, you might start with an S&P 500 fund like the Vanguard S&P 500 ETF (VOO) or SPDR S&P 500 ETF Trust (SPY), then add a Nasdaq tracker like the Invesco QQQ Trust (QQQ), and a semiconductor-focused ETF like the iShares Semiconductor ETF (SOXX).
While these ETFs diversify your portfolio, they may also overlap, increasing your exposure to certain sectors or companies more than you intended.
Managing ETF Overlap
Imagine you invest a total of $30,000, allocating $10,000 each to SPY, QQQ, and SOXX. NVIDIA (NVDA) and Broadcom (AVGO) are top 10 holding in all three ETFs.
Concentration
As a result, you now own:
- $556 of NVDA via SPY
- $711 via QQQ
- and $844 via SOXX
and
- $136 of AVGO via SPY
- $490 via QQQ
- and $986 via SOXX
This totals $2,111 in NVDA and $1,612 in AVGO, or 12.4% of your entire portfolio in just these two semiconductor stocks. If you were only invested in the S&P 500, they would represent approximately 7% of your portfolio.
Are you comfortable with that level of exposure to just two stocks? You might be, especially considering how critical they have become to the development of artificial intelligence. However, it’s also worth noting that NVDA is up nearly 200% in the past year and AVGO 100%, increasing the risk of a sharp pullback in either one.
Diversifying
If this concentration concerns you, consider further diversification by choosing an ETF without NVDA in its top holdings. Being aware of ETF overlap can guide your future investments. For example, you might choose an ETF that further diversifies your current portfolio, such as the Schwab U.S. Dividend Equity ETF (SCHD), which focuses on dividend-paying stocks.
Tax implications
Instead of adding another ETF to your portfolio, you may consider selling SPY, QQQ, or SOXX. Beware that selling ETFs that have significantly appreciated can trigger capital gains taxes, which may be substantial depending on your holding period and tax bracket. Carefully consider the tax implications before making any portfolio adjustments.
🤝 How can Mezzi help?
Mezzi makes it easier to make these important portfolio decisions, particularly around concentration, diversification, and taxes.
Concentration: Our new Exposure X-ray feature allows you to see exactly how much you hold in stocks like NVDA across different ETFs.
Evaluating ETFs: View the top 10 holdings of any ETF to determine if the ETF will help you diversify or further increase your concentration.
Taxes: Mezzi helps you evaluate the most tax-efficient way to sell stocks in your portfolio by limiting capital gains tax, using losses to offset gains, and maximizing potential deductions.
