For those just getting started with their portfolio, it's easy to think that diversifying is the key to success. After all, the more well-rounded an individual is when it comes to investing their money, the less likely they are to go under just because one of their investments does the same. But there is such a thing as being too diverse in the market — especially if the market happens to be on the decline. See why this is and what you can do about it so before you begin branching out.
1. Fees for Everything
Some investors want to balance out practically every risk when it comes to their portfolio. They may wind up with 30 securities or more just because they believe it's the only way to mitigate their losses in the case of a drastic collapse. The rewards may not be very big for the investor, but at least the risk is also correspondingly low. But while the actual inherent risk may be low, investors are still being charged small fees for all of their transactions. After a while, those fees may start to eat up any potential gains from the investments.
2. The Market Takes All
When the market takes a fall, it tends to take the majority of investments with it. This ultimately means that no matter how diverse your portfolio is, it won't be able to help you. Plus, there's no telling exactly how the market will rebound from the hit, which can make an individual investor's come back after the crash that much more difficult. If your chosen industries don't all level out to the same rates after the market stabilizes, you could potentially take a big loss from one sector of the economy.
3. There's Too Much Variance in Commodities
With the value of commodities constantly rising and falling, there's usually too much variance for investors to ride the wave and still come out on top.1 Those who do choose to invest in commodities achieve their success by trading them as opposed to holding onto them. However, this type of constant trading takes a lot of time, analysis, and effort. For an average investor who isn't going to spend hours every day tending to their portfolio, diversifying into commodities may not always be a sound long-term approach.
4. You're Missing the Illiquid Investments
It's relatively easy to start playing the stock market these days as opposed to buying up vacant homes and plots of land. But investors who choose to diversify in common liquid assets may be missing the most important opportunities of all when it comes to maximizing the strength of their portfolio. Real estate investment trusts (REITs) and hedge funds may tie up your money for a while, but they may also prove to be the most profitable ventures when it comes to your strategy.
5. There Is No Guarantee
Every move an investor makes may be the wrong one, which is why it's more important to take calculated risks rather than to blindly invest in everything. When the market is good and everything is on its way up, diversification will look like the only smart move because practically every venture is yielding incredible returns. It's why the advice to diversify is so prevalent in the financial world. And yet, there's another side to diversification that isn't quite as exciting for investors if the market should take a turn for the worse.
Much like anything in life, the key to diversification is to go into each investment with both eyes open and to balance out each security without negating their returns. There is no magical advice that an investor can get, but there are smart ways to approach a portfolio to give you the best possible chance.