We all have been told that Diversification is a Good Thing. Having investment in only one stock (or one company or one entity) is dangerous and highly risky. We are told: Don’t put all your eggs in one basket. We are told to spread out our risk.
So
So what is acceptable diversification? When is risk “satisfied”? Is ten, twenty, forty, one hundred companies acceptable? When is too much just too much?
Perspective
As you would surmise, there is no hard and fast rule as to how much diversification is too much. As in all things… it depends.
When, for example
First let’s look at time. When one is first starting out to invest, and has little funds, then diversification on a large scale is inappropriate, foolish, and a bad idea. In such a case, large scale diversification would be detrimental. However, as time progresses, and more funds are available, then diversification becomes significatly important.
As my holdings grow, if all my funds were in one company alone, then any business decline, for whatever reason, would impact me disproportionally. Thus, diversification is the right thing to do.
Industrial diversification
Another aspect of diversification is not just to invest in more than one company. One must also invest in more than one industry. If I invested in muliple companies but they were only in one industry, I would also be undertaking an inappropriate amount of risk. Many industries are cyclical. Many industries periodically run into regulatory, legal, headline, or other kinds of setbacks. By diversifying, I can at least not be at the mercy of any one kind of event.
Portfolio
The size of one’s holding serves as a good benchmark for diversification. A person with, say, one thousand dollars in their portfolio faces a different question than one who’s portfolio is $100,000, and is different than a person who’s portfolio is $1,000,000. As one’s holdings grow, one has the opportunity to broaden their diversification confort level.
So we may say that the state of diversification is in the eye of the beholder. The appropriate level of diversification for any one person is their own standard to measure.
Other considerations
How much time does it take to manage one’s portfolio? Is record keeping becoming too comples. Is research into companies becoming burdensome? These all may be a sign of overdiversification.
How have you tamed the diversification question? Let me know here.
Snowballing Outside Edinburgh University is a painting by Samuel Bough, 1853. Courtesy Scottish National Gallery of Modern Art.
The post How Much Diversification Is Too Much? appeared first in Smile If You Dare.