What Does Investment Diversification Have In Common With An Infinity Pool?

Infinity PoolSimply stated, both of these seemingly disparate items appear to go on forever, i.e., they are endless.

In the case of infinity pools, this attractive architectural amenity is a real plus, particularly for high-end residential real estate properties.

However, when it comes to diversifying a mutual fund portfolio, it appears that the financial press, some fund companies, and many investment advisers see no end, or limits, to what fund investors should add to their portfolios for optimal diversification.

While purely fictitious at this point in time, it would not surprise me to see a Securitized Outer Mongolian Leveraged Yak Futures fund described as a “must-have,” or “compelling” addition to a fund investor’s portfolio for it to be truly diversified. Forget that such an offering may be mind boggling in its complexity and carry excessive risks. In so many words, investors are being told that they need to get as much diversification as they can get. More of a good thing has got to be good.

On that note, I would suggest that fund investors hit the pause button and consider the following.

In a recent book, The Investor’s Paradox [Palgrave-McMillan, 2014], the author, Brian Portnoy, quotes Albert Einstein as saying that “out of clutter, find simplicity.” Following Einstein’s lead, Portnoy describes individual investors as “being in a jam,” and explains the “paradox” of his book’s title as such:

“We [investors] crave abundant investment choices to meet daunting portfolio problems in a world of volatile markets, manic news flows, and shifting geopolitical rhythms. But the more choices we are offered, the more overwhelmed, less empowered, and ultimately less successful investors we potentially become. More is less.”

Portnoy’s message is that individual investors should focus on the “power of simplicity in a world of overwhelming choice.”

I realize that questioning the concept of diversification is akin to casting doubt on the value of mother love. That’s not my intention. The cliché about not putting all your eggs in one basket is common sense investing advice. What’s at issue here is how far an investor has to go, literally and figuratively, to diversify an investment portfolio.

One of the obvious benefits of a mutual fund is that of obtaining diversification through the purchase of a single security as opposed to having to buy multiple stocks and/or bonds to get the same diversifying effect. The next step is to look at some fund categories with differing risk-return characteristics to spread your funds among a manageable selection of baskets.

It’s not necessary, or advisable, to load up your investment portfolio with a large number of fund choices. A limited selection of broad market index funds and/or a judicious choice of quality managed funds should provide a healthy degree of portfolio diversification.

I’m going to let John Bogle, founder of the Vanguard Group, have the last word on this subject matter. He’s a strong advocate of the concept of investment “simplicity,” especially as this concept applies to individual fund investors. In his book, Common Sense on Mutual Funds, he says: “I truly believe that, generally speaking, it is unnecessary to go much beyond four or five equity funds. Too large a number can easily result in over diversification.”

Richard Loth is the founder and publisher of the Fund Investor’s Schoolhouse, a mutual fund investing educational platform for individual investors (www.fundschoolhouse.org).

Copyright © Richard Loth 2015  Fund Investor’s Schoolhouse™

 

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