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Common First-Portfolio Mistakes

Overdiversifying Into Overlap

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Overdiversifying Into Overlap

Six different large-cap growth funds holding largely the same 100 stocks creates the worst outcome: the expense ratios of six funds combined with the returns of one. You think you are diversified when you are just expensive.

Key takeaways​

  • Overlap occurs when two or more funds hold mostly the same stocks; this happens frequently between funds in the same category (all large-cap, all growth, all tech)
  • A person holding Fidelity Large-Cap Growth, Vanguard Growth ETF, and Schwab U.S. Large-Cap Growth is paying three expense ratios for essentially one portfolio
  • The solution is to use a simple allocation: one U.S. total market fund, one international fund, one bond fund; add specialty funds only if you have a specific thesis
  • "Diversification" is not measured by the number of funds, but by the composition of holdings; six overlapping funds is less diversified than three non-overlapping funds
  • Many investors overdiversify because they do not understand how funds work or because they read about diversification and interpret it as "own as many funds as possible"

How overlap happens​

A large-cap growth fund buys the 100 largest-cap growth stocks: Apple, Microsoft, Nvidia, Google, Amazon, Magnificent Seven stocks, etc. There are only about 300–400 large-cap growth stocks in the U.S. market. If you own three different large-cap growth funds, they will hold 60–80% of the same stocks.

Here is a real example from 2024:

Vanguard Growth ETF (VUG):

  • Top 10 holdings: Microsoft, Apple, Nvidia, Google, Amazon, Broadcom, Eli Lilly, Walmart, Pchip, Netflix
  • Expense ratio: 0.04%

Fidelity Growth Company Fund (FDGFX):

  • Top 10 holdings: Microsoft, Apple, Nvidia, Google, Amazon, Broadcom, Eli Lilly, Tesla, Walmart, MasterCard
  • Expense ratio: 0.74%

The overlap in the top 10 is 80% (8 of 10 are the same). The overlap in the top 100 is probably 70%+.

An investor holding both VUG and FDGFX is paying:

  • 0.04% on VUG
  • 0.74% on FDGFX
  • Average: 0.39% on the combined allocation

But the holdings are 70% overlapping. So they are paying for 1.39% of expense (blended), but holding a portfolio that is 70% the same. That is paying for diversification they do not have.

The illusion of diversification​

Many investors build a portfolio like this:

  1. Fidelity Large-Cap Growth: $30,000
  2. Vanguard Mid-Cap Value: $20,000
  3. iShares Small-Cap Growth: $15,000
  4. Schwab U.S. Large-Cap Value: $20,000
  5. Vanguard Total International: $10,000
  6. Vanguard Total Bond Market: $5,000

They see six funds and think "I am diversified."

But Holdings 1, 3, 4 are all U.S. stocks (total: $65,000 of $100,000). Holdings 1 and 4 overlap in large-cap exposure. Holdings 1 and 3 overlap in growth exposure. They are paying six expense ratios for exposure to maybe two or three distinct asset classes.

A simpler portfolio that is genuinely more diversified:

  1. Vanguard Total U.S. Stock Market (VTI): $70,000

    • Holds all ~3,500 U.S. public companies, large to small, growth and value
    • Expense ratio: 0.03%

  2. Vanguard Total International Stock (VXUS): $15,000

    • Holds all ~7,000 international companies
    • Expense ratio: 0.08%

  3. Vanguard Total Bond Market (BND): $15,000

    • Holds ~6,000 U.S. bonds
    • Expense ratio: 0.03%

This portfolio has zero overlap. You own the entire U.S. market (3,500 companies), the entire international market, and the entire bond market. You are truly diversified. You are paying 0.04% blended expenses.

The overlap penalty​

Let's compute the cost of the six-fund portfolio versus the three-fund portfolio:

Six-fund portfolio:

  • Blended expense ratio: roughly 0.35–0.50% per year (mix of 0.04% and 0.74% funds)
  • On $500,000: $1,750–$2,500 per year

Three-fund portfolio:

  • Blended expense ratio: roughly 0.04–0.05% per year
  • On $500,000: $200–$250 per year

The annual difference is about $1,500–$2,250 per year. Over 30 years at 6% growth on that savings:

  • Six-fund: $500,000 → $2,870,000
  • Three-fund: $500,000 → $3,120,000
  • Difference: $250,000+

And this is before accounting for the fact that the six-fund portfolio has overlap, which reduces the effective diversification and slightly reduces the expected return. Adding that in, the difference is probably $300,000–$400,000.

When holding multiple funds in the same category makes sense​

There are rare cases where holding multiple large-cap funds, or multiple value funds, makes sense:

  1. You are a true indexer and you are using different fund families for various reasons. For example, you might have a Roth IRA at Vanguard with VTI and a 401(k) at Fidelity with Fidelity's large-cap index fund. The overlap is acceptable because the accounts are segregated and the expense ratios are low (both are index funds).

  2. You are expressing a specific thesis. You think large-cap growth is overvalued relative to large-cap value, so you deliberately hold both. You are taking a bet on the cycle, not "diversifying." This is acceptable if you understand it and keep the allocation reasonable (e.g., 60/40, not 50/50 with six overlapping funds on each side).

  3. You have a tax loss harvesting strategy. You hold VTI and Schwalb's U.S. Total Market ETF, which are similar but not identical, so you can tax-loss harvest between them. This is acceptable if the expense ratios are both very low (under 0.05%) and the overlap is understood.

For a first-time investor, none of these reasons usually apply. Stick with one fund per asset class.

The decision tree: how many funds do you actually need?​

For a first portfolio, the minimum is two funds:

  • Vanguard Total World Stock ETF (VT): holds U.S. and international stocks
  • Vanguard Total Bond Market (BND)

That is it. You own all global stocks and all U.S. bonds. You are paying 0.08% blended expense ratio.

If you want to separate U.S. and international (slightly lower cost on the U.S. portion), the three-fund portfolio is optimal:

  • VTI (U.S. stocks): 0.03% expense ratio
  • VXUS (International stocks): 0.08% expense ratio
  • BND (Bonds): 0.03% expense ratio

If you want to be slightly more tactical and separate large-cap, mid-cap, small-cap, that is understandable but unnecessary. A four-fund portfolio might be:

  • VUG (Large-cap growth): 0.04%
  • VBV (Mid-cap value): 0.05%
  • VBR (Small-cap value): 0.05%
  • BND (Bonds): 0.03%

But for most first-time investors, VTI + VXUS + BND is optimal: simple, low-cost, zero overlap, truly diversified.

How to detect overlap in your portfolio​

Use a tool like Morningstar or your broker's portfolio analysis tool. Most brokerages now show you:

  • Holdings of each fund
  • Top 10 holdings of each fund
  • Overlap percentage between two funds

If you see two funds with more than 30% overlap, seriously consider consolidating into one.

A simple rule of thumb: if you can describe the two funds using the same adjectives (both large-cap, both growth, both U.S.), they probably overlap heavily.

How it flows​

Next​

Overdiversifying into overlap comes from not understanding how funds work. But the opposite mistake is also common: underdiversifying into a small number of favorite stocks or sectors, creating a concentrated portfolio masquerading as diversified.