Owning A Cap-Weighted Total Stock Market Fund And A Large Cap Fund Offers No Diversification Benefit

Includes: ITOT, IVV, IWB
by: Roger Nusbaum

Friday I had an article published at TheStreet.com that looked at the new iShares suite of ten core ETFs. In the article I came around to a point that I have made here before but is worth mentioning again.

Click to enlarge

The chart compares the iShares Total Stock Market ETF (NYSEARCA:ITOT), the iShares S&P 500 ETF (NYSEARCA:IVV) and the iShares Russell 1000 ETF (NYSEARCA:IWB) since ITOT's inception (the original symbol was ISI). Long story short, iShares suggests a strategy that involves ITOT and IVV (and other funds) to construct a "well diversified" portfolio. I added IWB to further make the point.

The point is the extent to which large cap domestic index funds are going to look very similar even if they track different indexes. There is not going to be any diversification benefit to owning a cap weighted total stock market fund and any sort of large cap fund. ITOT and IVV have the same top ten holdings with similar weightings of those ten. They will always look very similar to each other.

I've seen published portfolios in various places over the years and this sort of duplication occurs frequently. It can happen with other pockets of the market like foreign and fixed income.

Using broad index funds is a valid form of investing and a broad fund will capture a broad swath of the market but, as I said in the above linked article, owning a bunch of funds that actually capture the same thing makes for ineffective portfolio construction and could create a false sense of diversification.