Can You Over Diversify?

Some people can be surprised to learn one of the most effective ways to protect themselves from market uncertainty, swings and volatility is also one of the least expensive things to do – diversify your portfolio, selecting good investments in a variety of different areas to protect yourself. Studies have shown that roughly 90 per cent of an investor’s return comes from effective asset allocation. Balancing fixed income investments with stocks (local and international) can lead to positive returns while managing risk.

Diversification protects investors if a segment of the market drops because the higher a market segment rises, the greater the risk that there could be a drop or pullback.

We certainly saw concern about a potential pullback start to play out in the markets in the spring of 2017, with considerable talk about the Trump effect, which saw a jump and continuing climb in the markets starting in November 2016 following President Trump’s U.S. election win. The markets were excited about the potential promise of deregulation and significant tax cuts. However, by April, some experts started to urge that investors be cautious, as markets appeared fully valued and the Trump administration faced challenges passing legislation.

While many would consider diversifying your portfolio to be one of the basics of investing, doing it right is not always the easiest thing to accomplish. I’ve met with a number of investors who’ve wanted their portfolios reviewed only to discover that they are over-diversified. Their portfolios weren’t large enough for the number of different kinds of investments they owned, which can work against them because they don’t have sufficient funds in any particular group of investments to really reap a return when investments are on the rise.

There are several components that investors need to think about when building a diversified portfolio:

Portfolio size, goals and time horizon – Knowing how much you can invest, your goals and the timeframe you have to reach those goals all are important considerations in determining where you should invest.

Consider geography – Investors should not just restrict their thinking to Canadian markets. The TSX, for example, is heavily weighted towards financial, energy and resource equities. People wanting to invest in other segments may find better investment opportunities in American or international markets.

Consider mutual funds – For portfolios of less than $100,000, holding baskets of investments, such as mutual funds and exchanged traded funds (ETFs), may make a good option and a good way to spread your wealth geographically and across various sectors.

Active investing – Once you’ve built your portfolio, you will need to manage it. Come up with a plan and set targets to determine when to sell.

Whether it is the Trump effect or some other event, there are going to be ups and downs in the market that create uncertainty. One of the best ways to protect yourself is by having a diversified portfolio. With conditions constantly changing, it is important to periodically review the mix of your investments.

Allan Small is the Senior Investment Advisor with Allan Small Financial Group with HollisWealth, a Division of Scotia Capital Inc. (www.allansmall.com) as well as the author of How To Profit When Investors Are Scared. He can be reached at (416) 332-3863 or via email at allan@allansmall.com

This article was prepared solely by Allan Small, registered representative of HollisWealth ® (a division of Scotia Capital Inc., a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada). The views, including recommendations expressed in this article are those of Allan Small and not those of HollisWealth. ® Registered Trademark of The Bank of Nova Scotia, used under license. Allan Small Financial Group is a personal trade name of Allan Small.