Can a portfolio be too diversified?
Answers
896 points
jillybeansisme answered one year ago …
Well, analyze the portfolio -- is it really diversified or does it just hold alot of different investments? No single investment should ever constitute more than 5% of your entire portfolio. That alone means at least 20 different investments. But these investments should include different asset classes (value, mid-cap, foreign, large cap, growth, bonds, real estate, precious metals, etc.)
You can hold alot of different positions but if they're all in the same asset class, you still are not diversified! If your investments turn out to be heavy in an area, sell some of them.
2769 points
Oldman answered one year ago …
Not really:If you can accurately identify the positions as to their market cap, growth/value, U.S./foreign, characteristics. then diversification is O.K.
But, if you're dealing with mutual funds, then go to:
http://www.fundadvice.com
and look at their recommended portfolio.
There is a "Ultimate Buy-and-hold strategy" that as a 40% bond component (short-term and international holdings), + about 6 percent in the following classes:Emerging Mkts; S&P 500;U.S. small value; U.S. microcap.; REITs; U.S. Large value; Intl small value; Intl Large value; Intl Large cap; Intl small cap.
The author of the study and the site is an advisor from DFA, which has a good reputation for analysis and diversification...but you can't buy DFA's funds directly, and I don't recommend paying an advisor to do this sort of diversification/rebalancing.
This portfolio has a lot of International holdings, as does mine.
if you're thinking of restructuring a portfolio, I would do some additional research, consider some ETF's to cut the long-term costs of turnover and maintenance, and only rebalance if a sector/position exceeds or falls below its target significantly...If a single security grows to > 5 % of a portfolio, sell some; if a sector has underperformed from the industry/sector average, put new money in. The historical standard deviation over a 10 year period gives you an idea of the range of returns from that sector/industry.
Learn to use stop-losses to protect profits or principal in investments. In most cases, a 15% trailing stop-loss (as the position grows in value, plan to sell if it drops 15% from your "peak")...and a 25% stop-loss on principal invested (e.g. it cost $5000, so sell if it declines to 3750) will keep the horrors of a complete wipeout from severely damaging a portfolio. Position sizing is also important...no one security (stock or bond) should be more than 2% of an active portfolio; no more than 5-10% per sector or mutual fund. Jillybeanisme is correct.
Before you try a new type of asset class, e.g., mutual funds; ETfs;Closed-end Funds; Exchange-Traded Notes (ETN's), REITs, Commodities, Publicly Traded Partnerships, Royalty Trusts, etc. go to
http://seekingalpha.com
and do some research on the tax, and risks, associated with these investments. Be sure to go to linked sites, such as Morningstar re; Mutual funds; and IRS.gov, re taxation.
NEVER PUT COMMODITIES or PARTNERSHIPS into a tax-sheltered account, such as a Roth or IRA. Commodities aren't allowed in a shelter (e.g., GLD, IAU, SILV, that hold physical commodities will disqualify a tax shelter) and MLP's and Trusts file a K-1, and their UBTI can also disqualify the tax shelter, and you lose the other advantages of tax-loss and return of capital in the sheltered account!
142 points
zachmckinney answered one year ago …
A complete diversification of a portfolio gets rid of unsystematic risk. This gets rid of company or industry risk. If you are diversified, you are diversified. You can't be 'too' diversified.
However, on a personal basis, the only way you can be 'too' diversified is if you think a particular company or industry is going to do better than others and you have diversified this risk away (and you would prefer taking this risk).
As higher risk means higher return, if you think a particular industry or company is going to do well, you could expose yourself to more risk if you want to in order to achieve greater results.
2082 points
alanj answered one year ago …
It depends on what type of investor you are. If you are an aggressive investor and you are only holding say the Dow Index or the S&P 500 Index, then for you, you would be over diversified.
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3943 points
MNSL answered one year ago …
Further to above good answers I like to add some more:
As Alanj said It depend on what types of investor you are. It also depends on your experience and knowledge.
Investors have chosen diversification to minimize their risk. However this strategy is not 100% reliable. If you diversify in wrong assets and stocks you will lose everything. Instead if you invest in a business you know you will end up with great return. With all these diversification funds managers are finding difficult to show profit in their funds through out the world.
Sometime this strategy will give you great return provided you buy and sell in the correct time. However I have never tried this method.
In a bull market if you too diversify you will not lose much. Because you can easily dispose stocks in small quantity.
Some intelligent investors do not like diversification and they know how to pick great businesses to reap benefits in the long run. For example some investors will invest in less than 05 stocks.
Sometimes if you put all of your eggs in one basket you will end up with above average return. Once you become specialize in one sector you can get better decisions and you will have advantage over others.
Pl see following link:
http://www.investopedia.com/articles/01/051601.asp
119 points
zellic answered one year ago …
I wonder if some of the above are mutual fund sales people. MNSL to me has the best answer.
I myself don't care for mutual funds where you give a salesperson your money to manage, they charge you on average 2% a year in MERs. After 25 years half your origional investment is gone to fees. How do you make any money.
As a buy and hold investor I look at revenue generating. I buy 6 solid stocks with a strong track record (50 years or more) and plow my money into them. I then reinvest the dividends using both regular drip's or synthetic drip's provided by discount brokers. Over time the dividend revenue will will provide a nice retirement. I don't know about the US, but in Canada dividends are treated favourably by the tax department. Mine are done both in and out od my retirement plan.
In answer to your question. Yes you con be over diversfied. It can protect you on the downside somewhat, When the stockmarket is going up there are still some dogs holding back your total porfolio and restricting your earnings. All sectors do not rise at once.
379 points
dustbusterz answered one year ago …
yes a portfolio can be too diversified. As a matter of fact, i kind of side with Buffett who feels diversification is (for the most part) foolish. If you have taken your time , to do your due diligence on a company , and your convinced its a great buy, then why would you not be ready to bet most of your investing dollars(nothing more than you can afford to lose with out causing financial difficulties) but concentrate heavily on stocks your sure fit your profile for great long term investments?
Read more from dustbusterz379 points
dustbusterz answered one year ago …
zachmckinney seems to be trying to have his cake and eat it too cause on 1 hand , he says you cannot be over diversified. then turns right around and says sure you can. hmmmmmm wow hard to swallow that pll huh? anyway, zachmckinney , you can be over diversified , because by spreading yourself too thin, you hold your returns to minimalist returns over the years. i mean your gonna see maybe 4 to 6 % returns instead of a nice healthy 10 to 15 % that you might other wise see with more concentration.
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