Updated Sep, 2019

Should I diversify out of VDHG?

The question often comes up from new investors whether they should diversify out of just VDHG and add other funds, so they don’t have all their eggs in one basket.

So, let’s take a look at what VDHG actually is.

It’s a fund-of-funds that contains within it 7 other funds, which collectively invest in over 10,000 companies from 46 countries around the world, including large, medium, and small companies from both developed and emerging markets. It contains the entire investable world of listed companies.

The equities portion contains 40% Australian stocks and 60% global stocks. The global stocks are cap-weighted, meaning the collective market has priced every company at its current value, and having your investment maintained in this market-determined proportion is referred to as cap-weighted.

What you’re doing by adding funds is overweighting some markets that you already own in VDHG. If that was your intention, then fair enough, but don’t think you’re more diversified. You’re often less diversified as you have actually gone the other way and become more concentrated in a specific market. Concentration is the opposite of diversification.

The case where you would be more diversified is if you added an ex-Australia fund like VGS or IWLD (since Australian equities are heavily concentrated in the vanguard diversified funds).

Adding international equities to lower your Australian equity portion

The Vanguard diversified funds overweight Australian equities for two reasons.
1. Franking credits
2. Currency risk

If you consider the amount of Australian equities to be too much concentration, then adding a global equities fund seems like a reasonable option, although any more than one additional equity fund with VDHG and I’d just go the DIY route and use the main underlying funds separately to create your own proportions.

What it means when you overweight any other market

Overweighting Australian shares can provide some benefits such as franking credits and lowering currency risk, but for non-Australian shares, when you overweight a specific market, you’re saying that you know more than the entire collective market, which is mostly made up of institutions who spend millions hiring highly qualified and skilled people to research this stuff. For this reason, I would reconsider whether you really know more than the market to make this decision.

This is a great short video series that explains it well: Investing Demystified.