Why over diversification of portfolio can jeopardise your financial planning? Know expert view

Investments should be goal-based. But one of the most important factors in investment is diversification. While investing, you should diversify your portfolio according to your financial goals, risk appetite, age, income, and financial condition. Diversification helps mitigate market risk and helps you get a return in adverse situations. But just as everything has a limit, diversification also has one. One should not over diversify their portfolio. Not only can it imbalance your portfolio, it can also derail your financial goals.

Santosh Joseph, Founder, Refolio Investments and Germinate Investor Services, tells us about the drawbacks of over diversification of our portfolio. 

"Sometimes, when things get done overboard, resulting in over diversification, (diversification is an effective tool to optimise between risk and return), overdoing it actually defeats the purpose, leading to dilution or, in a case, even a loss of the right disposition to make money," says Joseph. Emphasising the importance of diversification, Joseph says that the primary reason is to have a mix of assets in your portfolio, which could be style-based, risk-based, or asset-based. 

"When you overdiversify, you are using too many variables to downplay the risk part, which is that you want to reduce the risk, and therefore you use too many assets or factors in the mix of the portfolio." 

The expert says that investors overdiversifying their portfolio should realise that there is an optimal weight, optimal size, and positioning of elements in investments.

"When you overdo this, you water down the entire proposition. Therefore, you neither get the best of any opportunity that is being tried to get captured in your portfolio. So over diversification leads to dilution, and dilution leads to disintegration of the requirements of the portfolio," he says.

Joseph says with a good portfolio, investors want to measure it against risk taken and reward, or the return potential.

So when they dilute the portfolio too much, they give up on the reward or the return potential of the portfolio, which beats the logic of diversification.

"There is an ideal number of assets that should be in a portfolio, or the number of investments of security in each investment," says Joseph.