The myth
Investing experts recommend that you diversify your portfolio. This helps you avoid the chance that a certain negative event in the market will have a huge impact on the value of your investments.
The more diversification your portfolio has, the less affected it could be from such events. That’s why some people believe that there’s no such thing as an overdiversified portfolio.
The reality
Diversification is done by making sure that new investments are in companies and industries that are either unrelated to, or have low correlation with, those of the investments you already have. You can even consider making investments in different countries to take things further.
However, overdiversification can happen. This is when you spread your investments around so much that the additional risk reduction from each new investment becomes incrementally small.
Overdiversification is likely to have a negative effect on the chances of achieving your money goal. That’s because, when choosing new investments, you’ll be focused more on how different they are from your current ones instead of on their earning potential.
The verdict: False.
There’s no doubt that diversifying your portfolio has advantages, and you really should be doing it to protect your money. However, you might have a hard time reaching your goals if you take it too far.
While there’s no one-size-fits-all figure, some experts say that the decrease in risk is minimal once you reach 20 appropriately diversified investments.
While you can go beyond this if you want, you should always check the potential effect on your portfolio’s performance and see how it might impact your goal.
Also, when selecting investment products for diversification, you should still use your risk profile as your guide. That way, you won’t expose your money to more risk than you’d be comfortable with and knowledgeable about.
