Key Points
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Many people mistake more funds with more diversification. Look under the hood of your funds to see how much overlap there is.
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Don’t ignore periodic portfolio rebalancing. This can help keep your portfolio aligned with your goals and force you to “sell high, buy low.”
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With the recent “Magnificent 7” rally, many tech-heavy ETFs have become overconcentrated. This increases potential downside risk.
- 10 stocks we like better than Invesco QQQ Trust ›
For as much good as the ETF industry has done in offering hundreds of ultra-cheap investment products targeting almost every market, sector, and theme, they’re not perfect. We often hear the phrase “set it and forget it” when it comes to investing. I’ve used it several times myself. While that theory works at a high level, it overlooks some of the problems that can still emerge from it.
If you follow a few important portfolio construction principles and revisit the composition of it periodically, you’re setting yourself up for long-term success. But ignore these hazards, and your portfolio could begin turning into something you don’t want.
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Ignoring portfolio overconcentration
Tech ETFs, including the Invesco QQQ ETF (NASDAQ: QQQ), have been elite performers over the past decade. But the big rally from the “Magnificent Seven” stocks has turned the fund into a highly concentrated, top-heavy portfolio that now carries extra risk.
The Magnificent Seven stocks plus Broadcom currently account for 44% of the index. As we saw from 2023-2025, investors didn’t mind much because this group was carrying the market higher. But as of March 30, Apple, Microsoft, Nvidia, Meta Platforms, Alphabet, Amazon, and Tesla were all trading at least 13% below their all-time highs. Suddenly, they were becoming a drag on the index.
Whenever a fund is heavily dependent on just a few stocks (or a portfolio is dependent on just a few stocks or funds), there’s an increased risk of lower lows. More true diversification might be the better choice.
Owning funds with high overlap
This is the classic misjudgment that more funds equal more diversification. It can if you’re combining ETFs that target completely different market segments. But if you’re just buying the funds with the best returns over the past year, for example, there’s probably a lot of overlap.
Consider someone who owns the Vanguard S&P 500 ETF (NYSEMKT: VOO), the Vanguard Total Stock Market ETF (NYSEMKT: VTI) and QQQ. Here’s how that combination can go wrong.
- VOO and VTI have 87% overlap. VTI owns the S&P 500 plus about 3,000 other smaller company stocks in minimal allocations. Performance will be very similar over time.
- VOO and QQQ have a lot of the same top 10 holdings, including all of the big tech/consumer stocks already mentioned. The S&P 500 has them in smaller weights, but the high-tech exposure is still there.
This is one of those instances where you need to go under the hood to see what you’re buying. Owning two funds with similar portfolios doesn’t offer much additional benefit.
A lack of regular rebalancing
Imagine a scenario where you established a portfolio with 70% stocks and 30% bonds around the beginning of 2022. Since then, stocks have gone much higher (even with the 2022 bear market), but bonds, especially Treasuries, have performed miserably.
Your original 70/30 allocation might look more like 80/20 now. That’s a significant move away from what you originally set up and may be more risky than you’re comfortable with.
Regularly reviewing your portfolio keeps your asset allocation aligned with your goals. Plus, rebalancing helps automatically “sell high, buy low,” which has been shown to improve returns over time.
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David Dierking has positions in Apple and Vanguard Total Stock Market ETF. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Broadcom, Meta Platforms, Microsoft, Nvidia, Tesla, and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
