As I commented before, the exchange traded fund (ETF) industry is replicating the development of the mutual fund industry: fee creep, new players and increasingly exotic products. If history does repeat itself, and the industry engages in similar sales and marketing strategies as mutual funds, an uneducated investor may merely be going back to the future: a portfolio of numerous high fee ETFs that may overlap each other with no coherent or long-term strategy.

Thus, in an industry pushing more and more product, how many ETFs is too many ETFs in your portfolio?

Let’s look at the "why" question first. Why are you investing in an ETF based portfolio? Primarily, an ETF portfolio allows the investor low cost, diversification and an ability to re-balance from time to time. The question of "what" or "how many" should always be answered by referring back to the answers to the question why.

I am going to answer the "what" and "how many" without specifics to a product. Product is product. The primacy of strategy should always be top of mind rather than on product. More practically, Canadian Capitalist does a superior job commenting on ETF product and reference should be made to his blog.

Instead, my post addresses whether you may be committing mutual fund-itis by buying too many ETFs by analyzing each asset class.

CASH

An ideal ETF portfolio should not be a fully invested portfolio. After all, one of the reasons why you build an ETF portfolio is to re-balance periodically to capitalize on market weaknesses and to prevent a drift away from diversification. Always keep cash around to utilize this advantage fully (good advice no matter what your investing strategy). How much? This is subject to some debate. I like keeping 5-10% of my portfolio  in normal times and between 10-15% in volatile markets.

FIXED INCOME

One could achieve significant fix income diversity by 3 fixed income ETFs although 2 is probably a better number. If you want full coverage without too much duplication, consider: (i) a government bond ETF (short term for greater predictability); (iii) corporate bond ETF; and (iii) real return (aka TIPS) ETF for inflation protection.

If you opt for two fixed income ETFs, and assuming you want some margin of safety, consider looking at a short-term government ETF and real return ETF.