5 Reasons Why Being Too Diversified Might Hurt Investments
It's easy to think that diversifying is the key to success. After all, the more well-rounded an individual is when it comes to investing their money, the less likely they are to go under just because one of their investments does the same. But there is such a thing as being too diverse in the market — especially if the market happens to be on the decline. See why this is and what you can do about it.
1. Fees for Everything
Some investors want to balance out practically every risk when it comes to their portfolio. They may wind up with 30 securities or more just because they believe it's the only way to mitigate their losses in the case of a drastic collapse. The rewards may not be very big for the investor, but at least the risk is also correspondingly low. But while the actual inherent risk may be low, investors are still being charged small fees for all of their transactions. After a while, those fees may start to eat up any potential gains from the investments.
2. The Market Takes All
When the market takes a fall, it tends to take the majority of investments with it. This ultimately means that no matter how diverse your portfolio is, it won't be able to help you. Plus, there's no telling exactly how the market will rebound from the hit, which can make an individual investor's come back after the crash that much more difficult. If your chosen industries don't all level out to the same rates after the market stabilizes, you could potentially take a big loss from one sector of the economy.
3. Stock Overlap
The use of mutual funds and exchange traded funds (ETF's) in investment accounts gives everyone the ability to have an unlimited amount of stocks or bonds in their portfolio. This is a blessing and a curse. The more funds you purchase the higher your chances of having stock overlap, which creates over diversification. This happens when more than one mutual fund or ETF that you own has the same stock inside. The average investor does not realize this nor how to analyze for it. Run a stock intersection report to determine if you are over diversified by having stock overlap in your investments.
4. You're Missing the Illiquid Investments
It's relatively easy to start playing the stock market these days as opposed to buying up vacant homes and plots of land. But investors who choose to diversify in common liquid assets may be missing the most important opportunities of all when it comes to maximizing the strength of their portfolio. Real estate investment trusts (REITs) may tie up your money for a while, but they may also prove to be the most profitable ventures when it comes to your strategy.
5. There Is No Guarantee
Every move an investor makes may be the wrong one, which is why it's more important to take calculated risks rather than to blindly invest in everything. When the market is good and everything is on its way up, diversification will look like the only smart move because practically every venture is yielding incredible returns. It's why the advice to diversify is so prevalent in the financial world. And yet, there's another side to diversification that isn't quite as exciting for investors if the market should take a turn for the worse.
Much like anything in life, the key to diversification is to go into each investment with both eyes open and to balance out each security without negating their returns. There is no magical advice that an investor can get, but there are smart ways to approach a portfolio to give you the best possible chance.
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This content is developed from sources believed to be providing accurate information, and provided by Booth Financial Planning, LLC. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.