Five mistakes to avoid in your ETF portfolio

Building an ETF portfolio isn’t as safe as it looks, and Marcus Padley has watched investors make the same five mistakes over and over.

44 years ago was when I stepped into my first stockbroker’s office. I have seen thousands of client portfolios. Some of you are making it extremely complicated and others of you are keeping it quite simple, and it works to keep it simple. And how do we do that? We do it using – guess what – exchange-traded funds. I’m going to tell you what I would do if I were in your position, trying to build an ETF portfolio to build my nest egg. What I’m also going to tell you is five common mistakes people building an ETF portfolio are going to make. In fact, you’ve probably already made one. Five ETFs that we hold in our current portfolio – I’ll tell you what we’re holding at the moment. And at the end, I’ll also tell you the one thing that’s going to separate you from all the other investors getting it wrong. Let’s give it a go.

Five ETF mistakes investors keep making

Okay, first of all, we’ll do the mistakes. First one, the most obvious one, is the one you’ve already made, which is to assume that all ETFs are better than shares and that they’re somehow clever or safe. Let me tell you, ETFs are exactly the same as shares. Some are dangerous. Many go down as well as up. Just because they’re exchange-traded funds doesn’t mean there’s something miraculous going on. They all represent a group of stocks.

You have to understand that it’s not safe just because it’s an ETF. Too many people are thinking, “I’m going to invest in ETFs, and that’ll be better”. It won’t – if you choose the wrong one. You have to do as much work for ETFs as you have to do with shares. There’s no shortcut.

The second mistake you’re probably going to make is to build an ETF portfolio as you would a share portfolio, where the creed is diversification. Some ETFs – say an S&P 500 ETF, even an ASX 200 ETF – already hold 500 or 200 shares. That is max diversification in a standard equity portfolio. In some cases, you really don’t need more. In that way, they are different from shares. If you go and buy 20 ETFs, you probably end up buying 6,000 stocks in five countries. Don’t overdo diversification.

The third one, which goes without saying, is not understanding the ETFs and the variety of ETFs. There are lots of them. There’s active – active’s got a fund manager involved, some human brain is directing traffic. Passive ETFs, they just represent an index or a sector or a group of stocks that doesn’t change. Nobody’s mucking about with it.

And then there are all the leveraged, hedged, unhedged and multiplier ETFs. You can get ETFs that will give you two times whatever the NASDAQ does, for instance. Do you really want that? That’s twice as risky. Some offer five times in the United States. So you need to understand what you’re getting into. Just because it’s got the tag ETF doesn’t mean there’s something brilliant about it. You still need to understand what the ETF is that you’re buying.

Mistake number four – we talked about not taking enough risk. You can take too much risk. Some of them are created with derivatives. They move a lot. They’re not like buying the ASX 200 or the NASDAQ or the S&P 500. They’re geared, leveraged. This is not safe stuff. This is volatile stuff. You’ll have to be on the ball.

And if you concentrate on one theme with five ETFs, you’ll find all your money squashed into one little risky corner. Just be careful about what they call concentration. You can take too much risk almost without knowing it if you buy very similar ETFs and you have a few of them in one portfolio.

Mistake number five is not paying attention. And again, there’s a tendency for people to think, because they’re exchange-traded funds, hey, my job’s done, I’m going to outperform for the rest of my life and be looked after. They are exactly like shares. You have to keep a good handle on what you’re holding. Nothing that you buy is buy and hold. Everything needs vigilance. Don’t ignore your portfolio just because it’s in exchange-traded funds. You need to pay attention.

The five ETFs in our own portfolio

So, we started our fund 18 months ago. I put my super into it. Its mandate is that it’s only allowed to invest in Australian-listed exchange-traded funds. Our fund has gone from 18 months ago with just my super fund in it – we now run over $160 million, and it’s growing. In our ETF portfolio, there are five holdings. I’m going to tell you what they are and why we hold what we hold.

What we hold at the moment is a bet on the US market and a bet on the whole AI theme. AI, Big Tech, networking, database, infrastructure. This is the strongest theme in the whole market at the moment. People are constantly questioning it. Of course they are. We want them to. You wouldn’t want to go along in ignorance. So yes, test the thesis, but for the moment, Big Tech is where it’s at.

Consequently, we hold four ETFs in the US. One is over the S&P 500. The great thing about that is that it is a very low-volatility ETF and moves with the S&P 500. You can sleep at night. You rarely wake up to the S&P 500 moving more than a per cent or two in a day. This is one of the safest ETFs at the moment as long as the Big Tech theme is running, and we have a big holding in that.

The other one we have a big holding in is the NASDAQ. It’s similar to the S&P 500, there’s a lot of overlap of stocks, but it gives us a further, slightly more pointy exposure to the Big Tech AI theme. Another ETF we hold is even more focused. It’s the FANG ETF. We actually hold the hedged one: ten stocks, 10% holdings in each one, and they keep rebalancing it. And those are focused very much on the big technology stocks in the USA, and you can buy it here with a click on the Australian Stock Exchange.

On top of that, we have an even more pointy holding, which is in the semi ETF, representing semiconductor stocks. Memory prices are going through the roof. Nvidia (NASDAQ: NVDA) is the lead stock in that space, and it has a lot of stocks geared to the building of the database infrastructure, and these are companies already making money. They are involved in the pick-and-shovel stage of the database build. All the big hyperscalers are building the first planetary brain effectively, and it’s going to be housed in these databases. The chips are already piling in. The money is already being made by the semiconductor stocks.

And we have one more holding in the Australian technology sector. This is probably more of a trade and more of a value investment than some of the others. It’s because software stocks have been sold down terribly globally because people think they’re going to be threatened by AI, and it has caused this huge crater in Australian technology stocks. It’s only a small sector in our market, but we think it’s a bet worth taking that these stocks have been oversold, that in fact AI could benefit, as many of the CEOs tell you, could benefit these companies, and yet some of them are 40, 50, 60% off the top, and there is some sign of them plateauing and turning. So we’ve had a go at a tech ETF representing the Australian technology sector.

And that’s our five stocks: IHVV, the hedged S&P 500 ETF, HNDQ, the hedged NASDAQ ETF, FHNG, the hedged FANG, SEMI, and then ATEC, the Australian technology sector. Now, don’t take that as a recommendation. Yes, that’s what I would buy now if I were sitting in front of a blank screen because we think that theme, the Big Tech theme, is so strong and persistent.

And yes, it will have ups and downs. It’ll be a bumpy ride on the way, but it’s the most obvious theme in the market. One day – it could be tomorrow – that will change. We will be selling those. You would have to follow what we’re doing in order to keep those up to date every day. So don’t just go out and buy them.

Deciding what theme to back

But if you are, another day, looking at the market, what you want to do is what we do, which is first of all decide whether you want to be in the market at all. That means you need a bull market. You need a bottom-left, top-right chart on the S&P 500, the NASDAQ, even the ASX 200. Otherwise, you are swimming against the tide.

So, are we in a bull market? Number one. The second question you’ve got is: what is the market obsessing over at the moment? It changes all the time. You remember it was milk powder, then it was buy now pay later, and currently it’s Big Tech, and more recently AI. And those themes are very strong. That’s why we’re in them at the moment.

One day that will change, but at any one time you want to think about what the market is obsessing about, and you can play almost any theme through ETFs. This is why you need to be vigilant as well, because nothing is forever. There is a lot of money moving in and out of themes these days. See our article about momentum trading, and this money moves in the same way, the performance of these thematics through ETFs will change.

To follow along with how we’re navigating this, sign up for a free 14-day trial of Marcus Today. And if you’d prefer a hands-off approach, take a look at MT20.

Staying ahead of the herd

And finally, the bit I’ve left to last, which is how to separate yourself from the herd of enough exchange-traded fund investors who are over-diversified and don’t pay attention. Be prepared to change your mind. You do not buy anything in the stock market with a long-term view. When I hear people talking about, “Oh, I think BHP Group (ASX: BHP) is a buy for the next two years”, they are just guessing, because nobody knows what’s going to happen tomorrow. In order for you to be a good investor, you need to be vigilant. You need to make decisions. You need to be prepared to change your mind. You are here to make money. You’re not here to be faithful to some theme forever. Be decisive. Pay attention. And sometimes be prepared to get out.