THERE’S a fine line between diversification and diworsification, and most investors, unknowingly, run right over it.
We’ve all been taught that diversification is the golden rule of investing.
Diworsification, describes excessive diversification which weakens investment returns, increases costs, and makes managing a portfolio unnecessarily complex.
It’s the financial equivalent of collecting hundreds of ingredients for a meal and ending up with a tasteless, overpriced dish.
So why do so many investors fall into this trap, and what can be done to avoid it?
Over-diversification happens for many reasons. One of the most common is the mistaken belief that more investments always mean less risk.
While that’s true up to a point, research shows that beyond 20 to 30 carefully selected investments, additional assets do little to improve risk protection.
Investors who keep adding new holdings in the hope of safety often end up with a diluted, underperforming portfolio.
Some take the approach of simply dividing their money equally across multiple funds or stocks, assuming this guarantees diversification.
It’s a simple method, but it often fails because many of these investments tend to move in the same direction during market downturns.
Without proper analysis, an investor might think they have spread their risk, only to find that everything falls together when markets turn sour.
Another way diworsification creeps in is through overlapping funds and exchange traded funds (ETFs).
Investors love the idea of broad exposure and often buy multiple funds, not realising that many hold the same underlying stocks.
A portfolio containing an S&P 500 ETF, a total market ETF, and a large-cap mutual fund might seem well-diversified, but, in reality, it’s just a collection of similar assets, leading to unnecessary redundancy.
Psychology plays a big role too. Many investors feel safer when they own many stocks and funds.
There’s a sense of comfort in knowing money is spread across many investments.
But, while this might provide emotional reassurance, it often results in complexity, higher costs, and weaker returns.
The biggest risk of over-diversification is performance dilution. If an investor owns just five carefully selected stocks, their returns will be driven by those strong performers.
But if they own 50, the impact of the best investments gets watered down by mediocre ones.
Studies confirm that over-diversified portfolios tend to underperform more concentrated, high-quality investments, so research is key.
Costs also rise unnecessarily. More investments mean more transaction fees, fund management costs, and tax inefficiencies.
Another overlooked problem is the complexity which comes with owning too many investments. When an investor owns too many funds or stocks, managing risk effectively becomes nearly impossible.
Perhaps the biggest illusion is that a highly diversified portfolio will protect against downturns.
In reality, during bear markets and financial crises, correlations between asset classes tend to rise, meaning almost everything falls at the same time.
True risk management requires selecting non-correlated investments rather than simply increasing the number of holdings.
Avoiding diworsification requires a more thoughtful approach to diversification.
Instead of adding more assets for the sake of it, investors should focus on selecting investments which truly complement one another.
A mix of equities, fixed income, and alternative assets can provide effective diversification without excessive complexity.
Keeping the number of holdings manageable is key. Most investors do not need more than 20 to 30 carefully chosen investments. Beyond that, the benefits of diversification begin to plateau.
Rather than trying to own everything, investors should focus on quality.
Businesses with strong fundamentals, ETFs which genuinely enhance diversification, and stocks with long-term growth potential are more valuable than a bloated portfolio full of overlapping or mediocre investments.
Over-diversification is a silent drag on investment performance. It doesn’t just fail to reduce risk, it actively weakens returns, increases costs, and makes managing money more difficult.
A well-assembled portfolio isn’t about collecting as many assets as possible; it’s about selecting the right ones in the right proportions.
So, take a look at your investments. If they’ve become a tangled web of funds and stocks, it might be time for a financial spring cleaning. Because in investing, sometimes less really is more.
Peter McGahan is chief executive of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. If you have a financial question, call 028 6863 2692 or email info@wwfp.net
