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.