Investment Portfolio Diversification Overload

Creating some investment portfolio diversification can be a bad thing if you take it too far. Everyone and their grandmothers are talking about the benefits of international diversification, or diversification over many different market sectors.

And to some extent it can be a good idea to combat unsystematic risk; however there is a point of over diversification. When people end up buying 10 or 20 different mutual funds each one invested into 100s or 1000s of different stocks they simply take the idea too far.

Every mutual fund out there seems to practice and preach diversification, while at the same time paying out mediocre returns that do not even beat the market. On the other hand people like Warren Buffett and other great stock investors talk about how over diversification can really hurt your returns.

"Wide diversification is only required when investors do not understand what they are doing" Warren Buffett

"I would not invest in mutual funds, but if I did, I would choose an index fund. For most small investors who don't have time to research individual companies, cheap index funds are the best way to invest in the stock market." Warren Buffett

Many investors seem to believe that they can diversify all of their risks away by simply buying a wide variety of stocks. When one investment goes down another investment is suppose to go up eliminating the negative effects. Tell that to all the mutual Fund holders who lost money in 2008.

The simple truth is while strategies such as hedging and diversification help investors to diversify away some of their risk doing too much of it is just ridiculous. There is no way someone can find 200 great investments at one time.

By diversifying too widely you are bound to get into a lot of bad investments as well as good ones. The problem is that a good majority of the money you make on the good investments will often go to pay for the money you lost on the bad investments.

It doesn’t make sense to buy an airline ETF or to buy stock in a market getting ready to crash simply for investment portfolio diversification. You wouldn’t flush your money down the toilet for diversification why invest in bad stocks?

Instead an investor can invest into 20 or so stocks and get a much higher return. This is because you can keep track of 20 stocks and actually determine whether they are worthwhile staying invested into, not true when you hold 500 different companies in 40 different countries like most mutual funds do.

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