Why Should You Not Over Diversify the Portfolio?

We all want to invest our hard-earned money in such a portfolio which generates handsome returns and maximise our wealth. For this purpose, we usually avoid concentrating our investments in 1 or 2 particular segments but we go for different asset classes.

It is a very popular saying 'Don't put all your eggs into one basket'. Diversification means investing your funds into a wide variety of instruments in order to reduce the risk. Diversification is a risk management strategy.

If you diversify your portfolio then you will be able to yield higher returns with lower risk as compared to a concentrated portfolio. Financial experts suggest having a diversified portfolio based on your risk appetite, return expectation and age.

There are various investment instruments available in which you can put your finds to achieve diversification such as equity, debt, bank deposits, post office time deposit, liquid funds, hybrid funds, PPF, gold, real estate, hedge funds, derivatives, international funds, etc.

Suggested reading Banks are cutting interest rates, What to do Now?

Benefits of Portfolio Diversification

• Diversification lowers risk
• Generates higher returns
• Offers additional opportunities
• Reduces the volatility of the portfolio over time
• You can adopt various investment styles

Suggested reading Why Select Debt Fund over Bank Fixed Deposit : 10 reasons

Why Should You Not Over Diversify the Portfolio?

We know that diversification is important but including too many funds in the portfolio makes it more complicated. Ideally, investing in 10 to 20 instruments in different asset classes is sufficient to provide diversification.

We do diversification to get more returns and have lower risk. Over diversification is a situation when we invest in too many funds than actually required and as a result the benefit of reduced risk becomes less than the loss of actual returns.

Suggested reading Is it beneficial to invest in bank fixed deposit (FD)

Disadvantages of Over Diversification

• Less chances for superior performance
• Difficult to monitor and successfully manage too many funds
• Chances of repetition will increase as there can be many common stocks
• Costly affair as more charges incurred for investing in too many funds
• Each additional investment lowers the expected return

Suggested reading What is Laddering of Bank Fixed Deposits?

Final Words

In portfolio management, under diversification and over diversification both are not considered good for the health of portfolio. You must check whether your portfolio is over diversified. If yes, you may consider portfolio consolidation. You can think of cutting down the size of your portfolio but at the same time you must also know that cutting down your portfolio size will involve some costs but believe that these costs would not matter much in a long run, if your portfolio size is reduced to an optimum level. The optimum portfolio diversification can be understood as to invest in a number of different assets which should be large enough to eliminate unsystematic risk but at the same time it should be small enough to maximise the returns.

Suggested reading Now Start SIP in Just 7 days with CAMS digiSIP

Share This : Anupama is a Co-Founder of CodeForBanks.com. She is an MBA (Finance) and Chartered Financial Analyst (CFA). She also carries a Fellowship degree in Life Insurance Sector and is a Master of Computer Application (MCA). She is an expert in Finance Field with an experience of over 18 years on different managerial positions in finance industry including Stock Market, Depository and Mutual Fund Sectors. Apart from that she has remained for few years in the field of marketing as well. Her suggestions and advice for investments have been very useful to many people.
Her vast interest & expertise in the field of finance have encouraged her to write the articles so that others can also get benefitted out of them. She never loses any opportunity to learn and be creative. She is a valuable asset for CodeForBanks.com & important resource to all those around her.