Exchange-traded funds are widely regarded as a simple and inexpensive way to invest, and many broadly diversified equity ETFs have delivered strong returns over the past decade. Yet numerous investors fail to achieve the returns theoretically available to them because of how they construct and manage their portfolios.
The first mistake is holding too many or unsuitable ETFs. A single fund tracking the MSCI All Country World Investable Market Index provides exposure to more than 8,000 companies in 23 developed and 24 emerging markets, including large, mid-sized and small companies. Consumer advocate Niels Nauhauser describes such a fund as sufficient for the equity portion of a portfolio, while ETF specialist Frederick Fischer recommends either one global core ETF or several funds covering different regions and company sizes.
A globally diversified equity portfolio can still lose around half its value temporarily, based on historical experience. Investors who are uncomfortable with those fluctuations may therefore consider adding bonds. Selling in panic during a market decline can turn temporary losses on paper into permanent losses.
The second mistake is trading too frequently. Research cited in the article indicates that investors often reduce their long-term returns by selling ETFs when markets become unsettled. Finance professor Martin Weber warns that successfully timing an exit and re-entry is largely a matter of chance, even when observers later interpret it as skill. His advice for long-term investors is to remain invested.
The third mistake is using equity ETFs for goals only a few years away. Broad diversification can reduce the impact of individual companies’ volatility, but it cannot prevent losses caused by market-wide shocks. Andreas Beck, who advises large investors, says equity ETFs are better suited to long-term wealth accumulation than to funding a specific goal at a fixed date.
Beck and other experts cite twelve years as a guideline for the minimum investment horizon for equities. Investors saving toward a known goal should gradually move portions of their assets from ETFs into fixed-income investments, fixed-term deposits or call deposits as the deadline approaches. This reduces the amount exposed to market volatility shortly before the money is needed.
The fourth mistake is selling all ETFs upon retirement. Retirement can still last 15 to 20 years, according to retirement planner Michael Huber, making continued investment potentially important. He illustrates the issue with a 67-year-old woman who has accumulated 240,000 euros through an ETF savings plan. If she leaves the money in a non-interest-bearing current account and withdraws 1,000 euros a month, it would last 20 years before taking inflation into account.
If withdrawals rise by 2.5 percent annually to compensate for inflation, she would need almost 307,000 euros to receive the equivalent of 1,000 euros a month over that period. With annual returns of 3.5 percent, she could instead withdraw an inflation-adjusted 1,100 euros from the beginning, according to the example cited.
The fifth mistake is ignoring costs. Although competition from neobrokers has lowered many custody and trading fees, savings-plan charges still vary considerably. Some providers charge a percentage of each execution, while others impose a fixed euro fee. A charge of 2.75 euros on a monthly 100-euro savings plan would reduce the amount invested by 990 euros over 30 years. Once the lost compound returns are included, the total shortfall would be more than 2,500 euros.
Investors should also check whether supposedly free offers are temporary. Some banks and brokers charge neither a custody fee nor execution costs, but the conditions may change after a promotional period.
The sixth mistake is creating concentration risks without realizing it. Combining an MSCI World ETF with a Nasdaq 100 fund and a dedicated artificial-intelligence ETF can leave a portfolio heavily dependent on the United States and a small number of technology companies. In the example discussed, U.S. shares account for nearly 80 percent of the portfolio, while Nvidia, Microsoft and Apple together make up 16.7 percent, despite the three ETFs holding 1,283 stocks in total.
The seventh mistake is placing too much emphasis on investment themes. ETFs focused on areas such as green energy, hydrogen or defense can fall sharply when the underlying trend loses momentum. Experts recommend keeping the globally diversified funds at the core of the portfolio and limiting thematic investments to a smaller allocation. One cited recommendation is a combined share of 10 to 20 percent, while other experts suggest 5 to 10 percent.
Markus Jordan of the comparison platform ExtraETF describes single-theme ETFs as specialized products that should be treated as temporary bets or speculation. Investors who enter or exit too late can suffer substantial losses or give back much of their gains.
The eighth mistake is failing to rebalance. Different asset classes and individual holdings do not rise at the same pace, so a portfolio’s risk profile can drift over time. A portfolio that began 2015 with 60 percent in the MSCI ACWI and 40 percent in short-term European government bonds would have shifted to an 80/20 allocation ten years later, according to the example.
Small positions can also grow significantly. A one-percent Bitcoin allocation added in early 2020 to a portfolio otherwise consisting of the MSCI ACWI and European government bonds would have grown to more than seven percent by 2025. Because Bitcoin has repeatedly fallen by 70 percent or more in its history, that change would also have increased the portfolio’s risk.
Experts therefore recommend reviewing and rebalancing portfolios regularly. One approach is to adjust the allocation once a year by selling part of assets that have risen strongly and adding to those that have fallen, thereby restoring the intended structure.
Sources: Handelsblatt.