Over Diversification is a Big Problem

Sector allocation and diversification are essential aspects of a portfolio. But sometimes, too much is as hurtful as too little… Let’s discuss diworsification, its impacts, and how to maintain a well-balanced portfolio.

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You’ll Learn

We must first define good diversification. What does it mean to have a balanced portfolio?
Although investing across all 11 sectors is not a problem per se, it could become a burden if investors select industries they don’t understand just for the sake of diversification. Mike explains why you don’t need all 11 sectors.
A similar issue sometimes happens for investors who want to invest in international markets. The principle is not wrong, but why is it better to limit ourselves to 2 or 3 markets? The answer is between taxes, currency, lack of context and weak regulations.
The biggest problem comes when an investor has 60, 70, 80, or even 100 stocks in his portfolio. The first issue is time. Analyzing so many companies quarterly quickly becomes heavy. How could lacking time harm someone’s portfolio?
An aspect that has a more significant impact than expected is how businesses are interconnected. A problem with one could hurt many. Mike gives the example of Home Depot (HD) and Tractor Supply (TSCO).
Over-diversification often means buying very similar companies in the same industry. For example, investors buy all the Canadian Banks, all the AI stocks, or all the big oil companies. An investor’s portfolio could be significantly affected if a recession impacts one or many industries. How many holdings per sector would Mike recommend to investors?
Also, buying many companies with the same business model could lead someone to pick a weaker one instead of focusing on the best assets only.
Let’s talk about performance. Are portfolios with 70-90 holdings offering better, weaker, or similar performance than those with 20-40 stocks?
In summary, the more stocks in your portfolio, the more diluted the results. So, while investors may feel they reduce risks, they also reduce their wins.
Vero wants to offer listeners a solution to prevent them from over-diversifying their portfolios. What’s the best way to avoid this and maintain a well-balanced portfolio?