Why ETF Composition Matters For Investors

When buying an exchange traded fund (ETF), mutual fund, or any portfolio of companies, it is imperative that investors take an in-depth look at what the core holdings of any such fund are, and specifically, what the weightings of each individual stock are in each portfolio.

This “looking under the hood” or due diligence process may unfortunately occasionally be overlooked by some investors that may blindly believe in the diversification power of ETFs or funds, ignoring risks associated with such investments.

Index ETFs for example (those tracking the broad stock market indices such as the Toronto tock Exchange, S&P 500, or Dow Jones Industrial Average) mimic the overall movement of these indices. Any stock market index is not equally weighted – its holdings in percentage terms are proportionate to the size (market capitalizations) of its component companies.

This means that when Apple Inc.’s (NASDAQ:AAPL) stock price goes up or down, the proportionate impact of a given move far outweighs the impact of any movement of a smaller company on the index (Apple is worth more than most of the S&P 500 combined).

There are various equal weight ETFs or actively managed ETFs out there for investors concerned about the underlying concentration risk many ETFs present.

For those looking for outsized exposure to large caps that have continued to outperform and want increased concentration in these companies, most ETFs will work. My only suggestion is that investors look under the hood before buying any security, ETFs included.

Invest wisely, my friends.