When is Portfolio Diversification too Much?

In the interest of putting as much money into savings and investments as possible, households are doing everything they can during the present economic calamity. Individuals and couples alike are downsizing to one car, switching to prepaid phone plans, and moving into energy efficient apartments in order to put a few extra dollar into retirement.

On top of excessive saving, many are also trying to diversify their portfolio as much as possible. The markets have been suffering over the last couple of years, and many industries will most likely never return to their full splendor. Because no one necessarily knows the direction of any industry, diversifying a portfolio is smart and an old school lesson. We've all heard, “don't put all your eggs in one basket.”

However there is a time when portfolio diversification can become too much, and can in fact, become dangerous.

Because gold and other treasuries skyrocket in times of economic downturn, many investors have started putting a majority of their portfolios into them. They aren't doing this simply for diversification; they are hoping to hit the market while it is hot and make the biggest bang for their buck they can.

Others place a majority of their money in a variety of mutual funds that cover a wide range of different investments. While this may be good in theory, they often become so diverse that they are often impossible to manage. When you aren't able to effectively watch your investments, you could lose out on big payments or suffer losses that could have otherwise been avoided

So what is a responsible investor to do – especially in a market like this? Easy:

Balance Your Allocation

Every portfolio needs a strong balance of stocks and bonds to perform well, and each investor should create that balance based on their savings needs. Younger investors may benefit from having more stocks than bonds, while an older investor nearing retirement would benefit from the safety of having more bonds than stocks.

Mix it Up a Little

Once you have determined the right bond and stock mix for you, make sure that you are adequately diversified between each asset class. What this means is that you need to make investments that complement each other, so should one go down, the others will go up. An easy way to do this is to simply choose a total bond market index fund and a total stock market index fund.

Watch Your Steps

After you have adequate diversification, remain wary of doing so any more. While you may find other good investments that could yield high returns, you could also start spreading yourself too thin.

Creating a great portfolio is, of course, a great way to get to an enjoyable retirement. But before spreading yourself too thin through over-diversification, carefully review your portfolio. If you find that you have a strong balance of stocks and bonds that are appropriate for your age, and find that those stocks and bonds are a good balance of domestic and foreign, then leave your portfolio alone. You're already getting the most out of diversification.