Balancing Risk and Return: Optimal Number of ETFs in a Portfolio - October 2025

As Exchange Traded Funds (ETFs) continue to dominate modern investment strategies, investors and fund managers face a critical question: how many ETFs should be held in a portfolio to achieve true diversification—without unnecessary complexity or diluted returns? 

Our report, “Balancing Risk and Return: The Optimal Number of ETFs under Markowitz Portfolio Theory” (October 2025), explores that question through the lens of Modern Portfolio Theory, providing a quantitative and practical framework for constructing efficient ETF-based portfolios.

Markowitz Modern Portfolio Theory emphasizes the trade-off between risk and return, highlighting that diversification can reduce unsystematic risk—but only up to a point. Beyond a certain threshold, adding more assets contributes little additional risk reduction while increasing costs and administrative burdens. 

This research applies these principles to Fund of Funds ETF portfolios, where overlapping holdings across global, regional, and sector ETFs can undermine diversification benefits.

Through historical simulations of returns, volatility, and correlations, the study identifies the “diversification sweet spot” for Fund of Funds portfolios to be around 6–10 ETFs. Portfolios with fewer than five ETFs tend to be overly concentrated, while those with more than twelve to fifteen show diminishing diversification benefits alongside higher costs and complexity. The analysis confirms that efficiency arises not from the number of ETFs, but from how well their exposures complement one another.

A key focus of the research is avoiding overlap—a common issue when global and sector ETFs hold the same major companies. By carefully selecting ETFs with distinct exposures, investors can ensure each fund contributes uniquely to the portfolio’s risk–return profile. The study also emphasizes the importance of sectoral and geographic diversification, combining global core holdings with targeted satellite allocations (such as technology, energy, and emerging markets) to balance growth potential and stability.

Beyond theory, the report incorporates real-world constraints such as management fees, trading costs, liquidity, and usability. Even though ETFs are low-cost vehicles, an excessive number of funds can erode returns through accumulated expenses and operational inefficiency. Liquidity and structural factors—like currency exposure and replication method—are also shown to influence portfolio performance in practice.

To illustrate these principles, the study presents a case study of an 8-ETF Fund of Funds portfolio, achieving an expected annual return of approximately 6.8% with a volatility of around 11%, placing it close to the efficient frontier. This example demonstrates that disciplined portfolio construction—anchored in global exposure and complemented by selective sector and regional tilts—can yield an optimal balance between risk, return, and manageability.

Ultimately, the research concludes that in ETF portfolio construction, more is not always better. The goal is to build a coherent, efficient set of ETFs that work together to deliver superior long-term outcomes, bridging the gap between academic portfolio theory and real-world investment strategy.

The full report can be downloaded here: