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Can Your Share Portfolio Be Too Diversified?

Feb 1, 2008
Most so-called market experts will tell you that you need to have a well-balanced share portfolio. They will probably trot out the old sayings such as having 'not having all your eggs in one basket' and 'spreading your risk', but is this really a good strategy?

Well of course there is no question that when investing in shares, you certainly should not be investing in just one or even a couple of companies. Why? Well because unless you are 100% confident about a specific company's future prospects, you're exposing yourself to an unnecessary amount of risk.

You're far better off spreading your money across a slightly larger number of quality companies than risking it all on just a few. After all if one of them issues a profits warning and it's share price tanks, the value of your overall portfolio will take a massive hit.

It obviously works the other way in that if one of your select companies dramatically increases it's earnings or is taken over, then your portfolio's value will rise dramatically, but this is clearly a riskier strategy than most investors are comfortable with.

The strategy most recommended by experts is to have a well-diversified portfolio across a range of different sectors. This is, in effect the completely opposite strategy to the one previously discussed in that if you are invested in several companies then any dramatic movement in one company's share price will not have anywhere near as dramatic an impact on your portfolio's value.

In that respect, therefore, it's obviously a far less riskier strategy, but in my opinion you can have a portfolio that's too diversified. For instance, is there really any value in holding shares in companies in lots of different sectors? After all if this is your strategy, you're effectively tracking the overall market and may as well buy into a tracker fund.

Furthermore do you really want some of your money invested in weak sectors such as retail, where the high-street retailers are having such a bad time at the moment?

In my opinion the best strategy is to invest in around 5-10 companies in hot sectors. For instance, in 2007 you would have done exceptionally well just investing in mining companies and oil equipment companies, which continued to rise dramatically over the course of the year.

Let the trend be your friend. The market will tell you which sectors are hot at the moment. With this information you can drill down into a particular sector and find the most promising companies or the ones that have lagged behind the overall sector.

This is, in my opinion, a far better strategy than spreading your money across numerous different sectors and companies, where you effectively act as a tracker fund, but of course the ultimate decision is up to you and your individual risk profile.
About the Author
James Woolley runs a blog that discusses all aspects of money including shares, property, running your own business, and wealth building tips in general.
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