3 Reasons Not to Over-Diversify Your Portfolio

Portfolio diversification is integral to any investment plan. It prevents us from an over-reliance on a single investment and can negate the risks of large losses should one of our investments tank. However, at the same time, over-diversification can do more harm than good. In this article, I will explain three reasons why we should not over-diversify our portfolio.

Pay higher fees

The more diversified and expansive our portfolio is, the more transactions we are likely to make. This means we will pay more in transaction fees that will eat into our returns. Furthermore, if you are like me and invest in overseas stocks, you may also have to pay monthly custody fees for each stock you hold. The more stocks you have, the higher your fees add up – slowly but surely eating away at your returns.

Insufficient time to monitor all your investments

Many investors, after doing initial research on the company and deciding to invest, forget that they still need to constantly monitor their investment to ensure their investment thesis remains intact.

However, if you find yourself overwhelmed and unable to monitor each of your holdings, you may have over-diversified your portfolio and bit off more than you can chew.

It’s good to have a high percentage of your portfolio in high-conviction companies

Warren Buffett is famous for making big bets on companies that he feels confident about. Likewise, individual investors should concentrate their portfolio on companies that they have a higher conviction on.

When we have a more concentrated portfolio, the stocks that perform well can have a greater impact on our overall returns. On the contrary, if we are over-diversified, the returns of our high-conviction companies will be diluted and have only a small effect on our overall returns.

The Foolish bottom line

Diversification is vital for portfolio management. However, over-diversification can be counter-productive. There is no one-size fits all rule for how many stocks we should carry. However, if you find yourself in a situation where you are unable to monitor all your investments or are paying too much in fees, then you may wish to downsize your portfolio and concentrate more on the higher-conviction stocks.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.