Portfolio Diversity Checkup! - diversify but not over-diversify

Aug 5, 2021

Diversification is crucial for mitigating concentrated risk in your portfolio. However, it's important to avoid over-diversification, as this can lead to subpar portfolio performance.

Traditionally, sector diversification is based on the type of products a company produces. While this approach offers some benefits, it doesn't fully protect your portfolio during downturns or crashes.

A more effective measure of a company's diversification might be based on its customer base rather than its products. Meaning,  a company’s diversification score depends on who it “sells to” rather than “what it produces”.  For instance,  Microsoft and Expedia both are classified under technology companies in the traditional “what it produces” sense, however during the COVID crash, if you notice, Microsoft's stock dipped by around 25% while Expedia's dipped by over 60%.

It's also important to recognize that excessive diversification can dilute portfolio performance, aligning it too closely with average market returns. Achieving the right balance in diversification is key to maintaining a healthy yield without unnecessary risk.

Request for a free diversification check-up on your portfolio.