Can You “over-Diversify” Your Assets?
A diversified portfolio is one of the keys to a successful long-term investment strategy. But can your assets be too diversified?
Technically not – investors always have new opportunities to distribute risk. However, because you probably do not have the time and resources to commit to achieving the ideal mix of funds, it is easy to over-diversify in certain areas. You don’t want to have so many holdings that you pay unnecessary commissions or you can’t keep track of your investments.
“The big risk of over-diversification is that you burden yourself with too many holdings to track and the oversight process can become cumbersome,” says Christine Benz, director of personal finance at Morningstar. “Also, your portfolio may end up looking a lot like the broad market, but you’ll probably pay much more for that portfolio than a cheap broad market index fund or ETF.”
The last part is key. If you are investing in low-cost broad market index funds like Two Cents and most personal finance experts recommend retirement savers, then there is no need to spend time, energy and money researching and investing in funds that expose you to the same ingredients. market. Because what you are doing is a kind of artificial diversification.
According to Morningstar , the study found that “when investors are faced with too many options, they will distribute their assets evenly across all options, rather than choosing only the right investments and allocating them in line with their financial goals.” This naive diversification , as Morningstar calls it, will hurt your retirement savings more than help: You pay, on average, four times as much for the same risks that lower-cost funds offer, Morningstar found .
“The average investor can achieve proper diversification by choosing one or two investment grade funds,” says Cheryl Aubert , a reward-only certified financial planner. Apart from this, there is no real increase in profitability or decrease in risk.
“What people don’t understand is that when they invest in two or three big-cap growth funds, for example, when you look at the breakdown by industry or company that different funds invest in, they are all investing heavily in that the same company, ”Aubert says. “Most funds in a certain category are quite similar in that there is a limited number of stocks that they can be invested in.”
At this point, you will no longer pay for the difference in performance, but for who the fund manager is. And it’s not worth it.
This is why strategies such as a portfolio of three funds are attracting so many followers. They are simple and will give you the best possible results in the long term. They can provide relatively easy access to decent rewards.