Portfolio Diversification: Too Much of a Good Thing? 

Any savvy investor knows that they shouldn’t put all of their eggs in one basket. Diversification is a wise way to reduce risk. But can you be too diverse?

The following looks at how much is too much, and the signs that you might be heading into dangerous territory.

All About Portfolio Diversification

• What is portfolio diversification? 

What is portfolio diversification?

Having a diverse portfolio is essential to balance risk and enhance gains. Your investments should be spread across non-related industries, so reducing the risk of loss and balancing the complete showcase of assets. 

How Much is Too Much? 

• Signs of over-diversification
• Negatives of diversification in portfolio
• How to avoid over-diversification

Signs of over-diversification

While there is no rule that states exactly how much is too much, there are some warning signs that you might be entering choppy waters.  

Red flags might include: 

• Holding assets that you don’t understand: While you might be happy to trust a financial advisor as to where to invest, you should always ensure that you have a grasp of the companies you’re investing in. These are often dressed up under the title of ‘alternative investments’. Although these might not necessarily be a bad thing, they might have associated higher risks that aren’t easily communicated.
• Having an excessive number of individual stocks: Not only does this become a management nightmare, but it can also lead to a host of tax complications. While 20 or 30 companies in a portfolio might be considered a good number, anything over that is ripe for being streamlined, both for ease of management and to reduce the risk what’s known as ‘negatives of diversification’ in the portfolio (see more below).
• Using multiple management products: While small investors might benefit from the use of these, consider if, on top of that, you really need a financial advisor to oversee this? Investment management has its place and can help with diversification, but you should consider the pros against the cons (high costs, an inability to adapt, and reams of red tape). 
  

Negatives of diversification in portfolio

The greatest risk of over-diversification is that the returns are reduced without a co-existing reduction in risk. While it’s true that every diversification lowers risk, there is a finite point where doing so becomes less than the rise in expected gains. 

This creates a negative of diversification in the complete portfolio. The investor has to commit excessive time to manage all the assets, focusing not on cultivating those with positive returns but instead on those that lose.

How to avoid over diversification 

This is quite simple. Don’t allow the portfolio to become unmanageable. Instead, concentrate on the sectors that work best for your circumstances, perhaps ditching those that you don’t understand. When managing a diverse range of assets, you must also consider the time you have available to commit to your efforts. Each minute that you spend trying to figure out a sector that’s hard to understand, or simply trying to keep track of all your investments, has a direct negative impact on how well the whole portfolio performs. 

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