Diversification: The Good and the Bad

Mar 2007 //

As even casual reasoning would suggest, diversification can be both good and bad.  On one hand, it reduces the risk that unexpected events will lead to below-average portfolio performance.  On the other hand, it also reduces the opportunity to achieve above-average performance—by including progressively less attractive investments in a portfolio and, eventually, creating a portfolio that looks increasingly like the overall market.  Belief in unlimited diversification is ideology, while a consideration of the appropriate degree of diversification is analysis ... meaningful diversification involves much more than simply picking investments from different industry classifications.  It requires a much deeper knowledge of how companies operate in different interest rate, economic growth, energy price and credit spread environments.