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ETFs and Risk: Keep Diversification Simple

You can build yourself, at least on the domestic side of your stock holdings, a pretty well-diversified portfolio with but four ETFs: one small value, one small growth, one large value, and one large growth. With industry-sector investing, you would need a dozen or so ETFs to have a well-balanced portfolio, and that may be too many.

That philosophy holds when it comes to global investing. Yes, you can, thanks largely to the iShares lineup of ETFs, invest in about 50 individual countries. (And in many of these countries, you can furthermore choose between large cap and small cap stocks, and in some cases, value and growth.) Too much! Keep it simple and go with larger geographic regions: U.S., Europe, Asia, emerging markets . . .

You don’t want to chop up your portfolio into too many holdings, or the transaction costs (especially with ETFs that require trading costs) can start to bite into your returns. Rebalancing gets to be a headache. Tax filing can become a nightmare.

And, as many investors learned in 2008, having a very small position in your portfolio, say less than 2 percent of your assets, in any one kind of investment isn’t going to have much effect on your overall returns anyway.

As a rough rule, if you have $50,000 to invest, consider something in the ballpark of a 5- to 10-ETF portfolio, and if you have $250,000 or more, perhaps look at a 15- to 25-ETF portfolio. Many more ETFs than this won’t enhance the benefits of diversification but will entail additional trading costs every time you rebalance your holdings.

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