Too Much Diversification Can Hurt You

How to know if your efforts to reduce risk by diversifying investments have gone too far

You seek to protect your assets by diversifying them - allocating them among stocks, bonds and cash. And you can further manage risk by picking more than one investment within a class: You might hold not just a single stock fund, but one fund for blue-chip stocks, another for smaller stocks and a third that invests overseas.

So far, so good. But it is possible to overdo diversification. If you split your savings among so many investments that you can barely keep track of them all, you may be over-diversified.

The more investments you own, the more likely you are to have duplication and overlap in your portfolio - too many funds that invest in the same type of securities, asset class or even in the same companies. Instead of more diversification, you may actually be getting less.

If you invest in too many funds, even superior performance by one or two investments may not do as much as you would like to increase the total value of your portfolio. Over-diversification may not go as far as you hoped toward reducing risk, either.

The answer is to cut back to a number of funds you can manage easily: no more than one or two bond funds and perhaps three or four stock funds. Keep the ones in each asset class with the best long-term performance. Of course, you will also need to consider a fund's fees and expenses, as well as your own tolerance for risk.

Consider turning the job of monitoring your diversification and asset allocation over to professionals by investing in one target-date fund. You choose your fund based on the year you expect to retire. Then the fund's managers pick assets appropriate for your current age and continually adjust the asset mix as you get closer to retirement.