How many financial sector ETFs should you hold in your portfolio?
For most investors, holding just one or two financial sector ETFs is sufficient. A single, broad ETF provides ample diversification, while adding a second can be strategic for targeting specific sub-sectors like PSU banks or fintech.
How Many Financial Sector ETFs Should You Hold?
Many investors believe that buying more funds equals more safety. They buy three, four, or even five different financial sector ETFs, thinking they are spreading their risk. This is a common mistake. For most people, the right number of financial sector ETFs to hold is surprisingly small: one or two is usually enough. Effective investing in banking and financial sector stocks is about smart concentration, not just mindless diversification.
Holding too many ETFs that track the same sector can lead to problems. You might end up owning the same handful of stocks over and over again, defeating the purpose of diversification. You also pay more in fees and make your portfolio unnecessarily complex. Let’s break down why simplicity is often the best strategy here.
Why One Broad Financial ETF Is Often The Perfect Choice
An Exchange-Traded Fund (ETF) is a basket of stocks. A single financial sector ETF might hold shares in 20, 30, or even more companies. This includes a mix of private banks, public sector banks, insurance companies, housing finance companies, and other financial institutions. By buying just one unit of this ETF, you instantly own a small piece of all those companies.
Think about it. One transaction gives you exposure to the entire financial landscape. This built-in diversification is the main appeal of an ETF. A good, broad financial sector fund already does the hard work for you. It captures the performance of the industry's leaders and rising stars.
For example, a typical Indian banking ETF will have its largest holdings in giants like HDFC Bank, ICICI Bank, State Bank of India, and Kotak Mahindra Bank. These companies make up a huge portion of the financial market. A single ETF provides you with significant exposure to them, all while charging a very low management fee. Why would you need another ETF that holds the exact same stocks?
Simplicity is a powerful tool in investing. A single, low-cost, broadly diversified ETF is often the most effective way to gain exposure to a sector without adding unnecessary complexity or cost.
The Big Problem with Owning Too Many Financial ETFs: Overlap
The single biggest reason to avoid holding multiple financial sector ETFs is high overlap. This means that different ETFs often hold the very same stocks in very similar proportions. You think you are diversifying, but you are actually just concentrating your money in the same few companies.
This is what is known as false diversification. It feels safe, but it isn’t. Let’s look at a simple example. Imagine you buy three different popular banking ETFs.
Example of ETF Overlap
| Top Stock Holding | Percentage in ETF A | Percentage in ETF B | Percentage in ETF C |
|---|---|---|---|
| HDFC Bank | 25% | 23% | 27% |
| ICICI Bank | 22% | 24% | 21% |
| State Bank of India | 10% | 11% | 9% |
| Kotak Mahindra Bank | 9% | 8% | 10% |
| Axis Bank | 8% | 7% | 8% |
As you can see, all three ETFs are dominated by the same five banks. By owning all three, you haven't spread your risk. You have simply tripled down on your investment in HDFC Bank and ICICI Bank. If those two stocks perform poorly, your entire financial sector allocation will suffer, no matter how many ETFs you hold.
Besides overlap, you also face:
- Higher Costs: Each ETF has an expense ratio. Three funds mean you are paying three sets of fees, which can eat into your long-term returns.
- More Complexity: Tracking the performance of three funds is more work than tracking one. It makes rebalancing your portfolio more difficult and time-consuming.
When Holding Two Financial ETFs Can Make Sense
While one ETF is enough for most, there are situations where holding two can be a smart move. This is best done using a “Core and Satellite” approach.
Your Core holding should be a broad, market-cap-weighted financial services ETF. This is the foundation of your sector allocation, giving you exposure to the whole market. It should make up the majority of your investment in the sector, perhaps 70-80%.
Your Satellite holding is a smaller, more targeted investment. This is where you can make a specific bet on a sub-sector you believe will outperform. This might be:
- A PSU Bank ETF: If you believe public sector banks are undervalued and poised for a recovery.
- A Private Bank ETF: If you want to focus exclusively on the growth of private sector lenders.
- A Fintech-focused ETF: To bet on the growth of digital payments and financial technology companies.
By using this strategy, you maintain a diversified base with your Core ETF while using the Satellite ETF to add a little extra punch. This is an intentional strategy, which is very different from accidentally buying three ETFs that all do the same thing.
Your Simple Checklist Before Investing in Banking and Financial Sector Stocks
Before you buy any financial sector ETF, run through this simple checklist. It will help you decide if one or two is the right number for you.
- Define Your Goal. Are you simply looking for broad exposure to the financial industry? If yes, one ETF is perfect. Do you have a strong belief that a specific niche, like PSU banks, will outperform the broader market? If yes, a Core and Satellite approach with two ETFs might work.
- Check the Overlap. Before you buy a second ETF, look at its top 10 holdings. Compare them to your existing ETF. You can find this information on the fund provider's website. If more than half of the top stocks are the same, you likely don't need the second fund.
- Compare the Costs. Look at the Total Expense Ratio (TER). For two very similar ETFs, the one with the lower TER is almost always the better choice. Over decades, even a 0.2% difference in fees can result in thousands of rupees in savings. The Securities and Exchange Board of India (SEBI) regulates these funds to protect investors, and you can find information on their portal. You can visit the SEBI website for more on investor education.
- Review Your Whole Portfolio. Do you already own individual shares of HDFC Bank or SBI? Adding a financial ETF that is heavily weighted towards these stocks might increase your risk concentration, not lower it. Always look at your sector allocation as a whole.
For the vast majority of investors, the answer is simple. Start with one high-quality, low-cost, broad financial sector ETF. Stick with it. Only consider adding a second, more specialised ETF if you have a clear and compelling reason. Keep your strategy simple, and you will be more likely to succeed in the long run.
Frequently Asked Questions
- Is one financial ETF enough for diversification?
- Yes, for most investors, a single broad financial sector ETF is enough. These funds typically hold dozens of stocks across banks, insurance, and other financial companies, providing excellent diversification within the sector.
- What is the biggest risk of holding too many similar financial ETFs?
- The biggest risk is high overlap, which leads to false diversification. You may think you are spreading risk, but you are actually just buying more of the same top stocks, like HDFC Bank or ICICI Bank, concentrating your risk instead.
- Should I invest in a financial sector ETF or individual bank stocks?
- An ETF is generally a safer and simpler option for most people. It provides instant diversification at a low cost. Buying individual stocks requires more research and carries higher company-specific risk.
- How can I check for overlap between two ETFs?
- You can check for overlap by visiting the fund provider's website for each ETF. Look for the 'Portfolio' or 'Holdings' section and compare the top 10 stocks and their weightings in each fund.