Every investor has heard about the importance of diversification. Simply put, with a well-diversified investment portfolio, you can minimize your losses without putting your long-term positive returns at risk. The trap some investors fall into is diversifying too much where it gets to the point that they have a false sense of security, they limit their returns or get overwhelmed with their investment strategies. Over-diversifying isn’t ideal for the long-term outlook of your investments and here are some of the main reasons why.
Thinking You’re Protected From Losses
Having a safety net and knowing you won’t lose all of your investments during harsh market volatility can give an investor peace of mind. However, during times like these when volatility is at high levels, it’s easy to be too diversified where you think you’re fully protected from a market crash. Depending on the investment strategies you have in place, this may not be true. Diversification will help minimize losses, but it doesn’t mean you are completely protected from taking a loss occasionally.
Too Many Investments To Manage
A well-diversified portfolio may include a combination of stocks and bonds, cash investments, and more. However, the more investment accounts you add, the harder it will be to manage all of them. Don’t let the concept of diversification make you lose control over your accounts. Find the right balance based on your risk tolerance and financial knowledge. If it gets to the point where your investment accounts are too much to manage, consider scaling back to make it more manageable.
Too Much Exposure In One Sector
Investors often get comfortable with investing in one sector and won’t branch out to other industries much. Diversifying within an industry is a good strategy, but you don’t want all of your exposure to be in any given sector. Your best bet may be to invest in a smaller number of companies in a sector that gives you the best chance of success and then look to other sectors to broaden diversification even more.
Limiting Potential Returns
The end goal for most investment strategies is to have enough money at retirement to live comfortably. And for most investors, this means having a good mix of higher-risk and lower-risk investment accounts. Diversification in your portfolio can lower the risk of losing all of your money, but too much of it can also limit your returns. Everyone has a specific tolerance for risk based on their long-term goals, so determining what your risk tolerance is will be a good first step to knowing how much diversification you will need in your portfolio.
The experts at Stock Investing Info enjoy passing on their financial knowledge to clients. Diversification is always one of the topics we discuss with our clients since every portfolio needs to have it. Finding balance is the most difficult part, but we can help you every step of the way. Feel free to contact us at any time and we would be happy to discuss different levels of diversification with you.