Di-worse-ification: …Not All Investments Are Equally Attractive

Jun 2004 //

…not all investments are equally attractive.  Assuming that we choose to buy the most attractive investments first, as we continue to expand our portfolio of investments, the expected return will decrease—as we add progressively less attractive investments.  Further, while additional investments would reduce risk, each additional investment would reduce risk by a progressively lesser amount.  (Adding an additional stock to a one-stock portfolio reduces risk by much more than adding one stock to a 100-stock portfolio.)  As we continue adding investments to a portfolio, at some point the reduction in risk created by additional investments is outweighed by the reduction in expected return caused by adding investments with progressively lower expected returns.  That’s when diversification becomes di–worse–ification (a term coined by Peter Lynch).