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High Concentrations Lurk Under Hood of Some ETFs

Sector and region ETFs are particularly prone to relying heavily on a handful of stocks.

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Exchange-traded funds have a lot going for them, to be sure. For investors seeking exposure to a basket of stocks that, unlike traditional mutual funds, can be bought and sold during the trading day, and with expense ratios that often undercut those of comparable mutual funds, ETFs are often the best way to go.

However, as useful as ETFs can be in assembling a diversified portfolio of stocks, bonds, and other asset classes, they must be used with care--in particular the many ETFs that provide exposure to a specific sector or region. Investors holding too great a percentage of assets in one sector or in the stocks of one country could be in for a rude awakening if a market jolt strikes either. Plus, you may already have exposure to the sector or region through other, more diversified funds in your portfolio, such with as a broad market index fund. But another, more hidden risk, involves ETFs that are highly concentrated in just a handful of stocks.

Adam Zoll does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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