Can you over-diversify an investment portfolio?

When it comes to diversifying your investments, I know you can under-diversify but can you over-diversify too? Diversification is, after all, about spreading your risk – or in other words, not putting all your eggs in one basket. When you add new investments to a portfolio, the extra diversification protects you from losing everything if one goes wrong. So surely the more you have, the better? Apparently not. As with most things, there’s two sides to the coin. If you over-diversity you’re diluting your good investments as well. Make sense?

“Diversification is protection against ignorance.” — Warren Buffett

Now, I wish I could say there’s a magic number of investments to hold in a portfolio, but the truth is, the number will change based on your risk appetite and the amount of money you have invested. For example, if you are starting out with £5,000 to invest, instead of investing in one stock you might invest in one fund instead – a fund that itself invests in 50 stocks. That way, your £5,000 is spread across 50 holdings, not just one. If you have £100,000 to invest, you may have several individual stocks in your portfolio as well as a number of funds.

If you are investing in more than one fund, you also need to think about what those funds are investing in. There is no point, for example, investing your entire portfolio in say five UK equity income funds. Not only are they all dependent on UK companies doing well, but the odds are a number of their underlying holdings will overlap too and you are not as diversified as you think you are. Diversification is more than just numbers – it’s asset classes, geography, sectors and individual companies too.

So how do you strike a balance? Maybe turn to the professionals.

Multi-asset funds offer a straightforward solution for many investors and one of the key attributes is they can invest in several different asset classes, with a professional investor making the decisions for you. Some invest directly in assets, others – multi-manager funds – invest in a selection of funds instead. Both these options allow for appropriate diversification across regions, sectors and asset classes. A number even have exposure to alternative assets for added diversification.

4 multi-asset funds to consider

BMO MM Navigator Distribution 

The managers of this fund aim to deliver investors a high and reliable income, with the potential for capital growth. It is a multi-manager, multi-asset portfolio, which generally contains between 25 and 35 individual funds, balancing diversification and risk. The managers are targeting a yield that puts the fund in the top 10% of income generators in its sector.

Jupiter Merlin Growth 

Jupiter runs a suite of funds under the Merlin label. The Merlin Growth fund is a fund of funds meaning it has at least 70% of the fund in other investment funds. The portfolios are managed by a very experienced team of multi-manager professionals and current holdings include other Elite Rated funds such as M&G Global Dividend and TB Evenlode Income.*

M&G Episode Income 

M&G Episode Income is a multi-asset fund that aims to produce monthly income by investing in a diversified range of assets. The term “episode” refers to those periods of time when investors’ emotions cause them to act irrationally. The fund manager uses behavioural finance to find pockets of value and invest against the herd rather than following it.

Ninety One Global Income Opportunities 

This fund invests conservatively around the world in a diverse range of equities and bonds. Asset allocation decisions start from an equity centric position and then other assets are used to reduce risk. The fund won’t ever have more than 250 underlying holdings.

*Source: fund factsheet, 31 August 2021