Broad Index ETFs Help Limit Portfolio Volatility | ETF Trends

While it feels good to correctly time a particular market segment, investors should not overlook the diversification qualities of holding a broad, index-based exchange traded fund, especially with the recent dip in momentum stocks.

A lot of investors fail to recognize that the diversification benefits of index ETFs are diluted if the investment is just a variation of a single theme, writes John Prestbo for MarketWatch.

For instance, tech and biotech ETFs both declined as their respective sectors fell on weakness from Facebook (NasdaqGS: FB) and Gilead Sciences (NasdaqGS: GILD). The iShares Nasdaq Biotechnology ETF (NasdaqGM: IBB) fell as much as 8.9% in the first half of April while the First Trust Dow Jones Internet Index Fund (NYSEArca: FDN) declined as much as 7.9%.

In contrast, broad market ETFs were only slightly affected. For example, the Schwab U.S. Broad Market ETF (NYSEArca: SCHB) only dipped 3.2% and the SPDR S&P 500 ETF (NYSEArca: SPY) dropped 2.9%. SCHB allocates 16.5% to tech and 12.5% to health care sectors while SPY has a 16.9% weight in tech and 13.1% in health care.

By investing in a broad index ETF, investors gain greater diversification and minimize portfolio volatility, whereas a highly concentrated ETF could overexpose an investor to sector-specific risks.