What is Diversification?

DiversificationDiversification is the strategy of investing in assets that are uncorrelated to one another. This simply means choosing assets whose values do not move in the same direction – up or down. Diversification allows investors to minimise their potential losses by not putting all their eggs into one basket. However, does diversification mean that investors should put each egg into a different basket and have hundreds of baskets to look after? Do you believe that you are over-diversified? There are three signs of over-diversification:

  1. Expenses – Regardless of whether an investor is diversified across various assets, such as real estate, stocks, bonds or alternative investments (such as art), expenses will likely rise simply based on the actual number of investments. Have you calculated your fees, charges and costs?
  2. Balancing – Having a diversified portfolio may mean that you have to be more involved in and/or knowledgeable about your investment choices. Are you aware of your investments to an in-depth level?
  3. Underperformance – Great investment returns require choosing the right investments at the correct time and having the courage to put a large portion of your investable funds toward them. Are you confident about being able to do this?

At the end of the day, having a diversified portfolio, perhaps one managed by a professional, may make sense for many people. However, beware, this approach is not without specific risks, such as higher overall costs, more accounting for and tracking of investments, and most importantly, potential risk of significant underperformance.