Too Much Diversification Is Not a Good Thing

Physician's Money Digest, April 2006, Volume 13, Issue 4

Investor's Business


The mantra of financial advisors shouldbe familiar to physician-investors: Diversifyyour portfolio. A key to investing success,diversification is a portfolio strategy thatreduces risk by spreading assets among avariety of investment vehicles, such asstocks, real estate, and bonds. Because notall asset classes move in the same direction,volatility is reduced, and your portfoliocan deliver consistent results. Once youdecide on the amount to invest in equities,the remainder is distributed among myriadmutual funds. But what happens if youdiversify too much? poses this question of overdiversification,cautioning that three things canoccur. First, investors who spread theirassets too thin may forfeit gains in moreprosperous areas for funds that continueto lag or underperform. Second, you spendtwice or more in expenses and fees to variousfunds rather than staying with a coupleof fund managers who can outperformthe market. Third, you waste time trying tokeep up with the performance of variousfunds with the same goal. How manymutual funds is enough? According to thearticle, Jim Peterson, head of CharlesSchwab's mutual fund research, says thatthree funds in any one asset class is morethan enough diversification, and manytimes one mutual fund can do the job.