How To Avoid Over-Diversifying Your Investment Portfolio

September 11, 2017 Investments

If you over-diversify your investment portfolio, the result will be a large collection of small, fragmented holdings. This means that the contribution of an investment that has generated good returns in the past could become insignificant in your portfolio. As well, you can expect that with an over-diversified portfolio, management costs and taxes will reduce your investment returns too.

To avoid the scenario of an over-diversified portfolio you must first decide on the ideal allocation to various asset classes. This approach has to suit your return requirements, tolerance for risk, and long-term investment outlook. Next, you have to categorize the investments you hold into the asset classes identified in the first step. By doing this, you will be able to determine what fits where in the ultimate plan of things.

In addition to the steps outlined above, you may have to make additional investments in assets that you are under exposed to, and likewise sell those you are over-exposed to. This will bring your portfolio in line with an asset allocation that is suitable for you and your financial goals. Finally, you have to consolidate your holdings into a few core investments that have consistently performed well.

Investments with narrow mandates, investments that have a high cost and whose performance has not been consistently good, are other investments you should consider selling.

Once you have completed this exercise, you will have a compact investment portfolio that will make it easy for you to monitor investments, and to make make certain they are performing well and on track to deliver the returns you need.

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