We recently discussed the issue of over-diversification and some of the most common side effects that investors generally report from having over-diversified portfolios. These issues could include a lack of focus or a general lack of understanding when it comes to investment decisions – especially for new investors. However, when we consider the issue of over-diversification, it generally leads many investors to question their own portfolios. Many of you may be wondering, “is my portfolio over-diversified?” or “what is the sweet spot level of diversification that I should be aiming for?” While the answers to these questions may vary based on your investment strategies, we have put together a list of several of the most common signs that your portfolio may be over-diversified, so that you can assess your own investments.
1. Owning Only Mutual Funds – And Not Knowing Where They Are Similar
Mutual funds can be extremely useful investment vehicles – especially for newer investors looking for a good way to diversify their portfolios. However, just because something works well does not mean it should be used in excess! One problem with owning too many mutual funds is that, while the funds you own may sound like very different investments, they can actually be very similar in terms of their investment holdings. This can become a problem because owning two mutual funds that are very similar can make you feel as though you are doing a good job at diversifying, when in reality each fund might leave you with very similar results. To combat this issue, it is best to read up on the mutual funds you’re looking into before you buy. Familiarize yourself with their strategies, their value propositions, and their holdings, so that you can know what things to look for if you are to go in on another mutual fund.
2. Owning An “Excessive” Number of Individual Stock Positions
Owning too many stocks can be a surefire sign that your portfolio is over-diversified. After a certain point, every additional investment you make will drive less and less individual value. So, what is the key number of stocks for an investor to own, then? Most investment professionals will agree that the number of companies is somewhere between 15 and 30. However, it is best not to get too fixated on any exact number – as long as you’re not invested in too many!
3. Owning Investments That Are Not Fundamentally Different from Other Investments You Already Own
Finally, you may be able to get a sense of over-diversification in your portfolio if you go back and analyze the positions that you have. Do you have investments that are fundamentally similar to each other? Think of this in terms of the company’s industry, philosophy, business strategy or market cap. Or, if you are invested in assets other than stocks, how is the structure of each asset different from the next? If you are sensing that you have a lot of investments that seem very similar, you might want to reconsider the positions that you have. One way to alleviate this problem is to plan a set structure for your portfolio by selecting different asset classes or industries and re-assess that structure periodically to make sure that you are staying within your bounds.
The bottom line here is that there are many simple ways to see if you have over-diversified your portfolio. By taking a step back and analyzing the current investments you own, you might be able to paint a clearer picture of how to move forward with your diversification strategy!