How Investors Can Avoid The Scourge Of Overdiversification

How Investors Can Avoid The Scourge Of Overdiversification

“Investors who see diversification as a savior subject themselves to a tremendous scourge of lower returns from excess diversification.”

Diversification is a key part of successful long-term investing but it is also possible to overdiversify, and when this occurs, returns suffer.

Active fund managers and private investors try to diversify as much as possible. Theory dictates that this should help you lower risk and by widely diversifying, funds minimize their chance of underperforming the index. However, many active fund managers overdiversify their funds to reduce portfolio volatility, which in turn reduces the business risk of the active managers at the expense of clients’ return.

This closet indexing isn’t an attractive trait in...