Over-diversification of portfolio could give you insignificant returns. Here's what you should do
Posted by: Arti Bhargava on Jun 18, 2018, 06.30 AM IST
Pooja has been an involved investor for several years and has built a large portfolio of investments. She is confident that she has selected good products to invest in. To mitigate her risks, she has been investing small amounts in a large number of products.
However, Pooja finds that her portfolio is neither generating good returns nor is it protected from volatility. Moreover, she has also been unable to generate enough funds from her investments when she needed them. Pooja wants to know where she went wrong and what she can do to get her investments to work for her .
The trouble with Pooja’s portfolio is that it suffers from the ills of over-diversification. A large portfolio of small, fragmented holdings inevitably means that the returns generated by the portfolio will be insignificant. The other thing to note is that returns will be further diluted if she does not consider the cost and tax aspects of the investment.
Even if Pooja has evaluated the merit of each product before investing in it, she may not have considered meeting her needs from these investments. In all likelihood, the products will be unsuitable for her investment horizon or she may end up having excessive exposure to a particular type of investment, thereby increasing risks.
To recover from this lull, Pooja has to take time to rework her portfolio by linking investments to specific goals or requirements. For starters, she has to decide on a suitable allocation to various asset classes given her broad return expectations, risk profile, investment horizon and goals. Next, she has to categorise the investments she holds into these asset classes and eliminate those that do not fit into her plan. She can make additional investments in assets that she has less exposure to and sell those that she is overexposed to.
Lastly, she has to consolidate her holdings into a few core investments that have been performing consistently. Collating these investments will help re-evaluate the rationale for each investment. Investments with narrow investment mandates, such as sector funds, investments that have a high cost with inconsistent performance, should be sold.
Once Pooja completes this exercise, she will have a set of investments that will work towards meeting her goals.