Diversification is preached by everyone in the finance industry. It's a way to reduce your investment risk and give you exposure to a number of different asset classes. For some investors however, diversification can be a bad move. Depending on the amount you have to invest and your investment knowledge, diversification could be impractical and way more costly than you would think. Here are six problems with diversification. (For a background, check out The Importance Of Diversification.)

In Pictures: 20 Tools For Building Up Your Portfolio

1. Diversification requires a lot of money to get started.
If you want to have a truly diversified stock portfolio, it could end up costing you a pretty penny. Do you think $10,000 is a lot of money? Not at all! It takes at least $10,000 to be properly diversified amongst different stock sectors. It would cost $10,000 if you just placed $1,000 in a stock in technology, real estate, oil and gas, healthcare, consumer staples, retail, financial, transportation, natural resources and a cyclical stock. Ten-thousand dollars would buy you the minimum exposure to all of the largest sectors in the market.

2. Diversification is time consuming.
It can be a full-time job keeping up with the prices of stocks in different industry sectors. You have to be an informed investor which means staying up to date with major news, listening to conference calls and reading quarterly reports for important information. This can be quite a time commitment. You may feel overwhelmed trying to keep up with the ins and outs of your portfolio on a weekly basis. (For more, check out The 4 Key Elements Of A Well-Managed Portfolio.)

3. Diversification can make investing more expensive.
In an attempt at rapid diversification, new investors have a tendency to load their portfolio up with blue chip stocks. The problem with buying big name companies is that they tend to be more expensive than mid and small cap stocks. Mutual funds, hedge funds and institutional investors are professional investors and they all buy the blue chip companies. You will end up paying a premium to buy a slower growth household name.

4. Diversification can be a tax nightmare.
The more stocks you own, the more 1099 DIVs and broker statements you will receive. This can make doing your taxes an ever bigger headache. You have to list every buy and sell transaction along with any distributions from your stocks during the year. That is exactly what you do not want, a way for your taxes to become even harder to do. (Check out 10 Steps To Tax Preparation for some tips.)

5. Diversification can hinder your ability to beat the market.
Most large cap companies have at least 30 analysts that follow the stock. These analysts spend their days researching and examining company data. They look at everything from financial data to industry trends. Companies that have a lot of analysts following them have a hard time exceeding analyst expectations, which makes big price moves less likely. Small and mid-cap stocks give individual investors the best opportunity to outperform the market.

6. Diversification can ruin your best ideas.
In some cases diversification can actually hurt the return on your portfolio. If you divide your portfolio up equally amongst all your investments, your best ideas may not get enough attention. You are actually allocating the same amount of money to your best ideas and your worst ideas! Your best ideas deserve a much larger chunk of your money than your worst ones. (For more on this, see The Value Investor's Handbook.)

The Bottom Line
Diversification may be touted as a one stop strategy that fits everyone due to its risk reducing aspects. However, some investors may find that diversifying their portfolio can be more expensive, complicated, and hurt their overall returns. For these investors, diversification would actually be diworsification.

Catch up on your financial news; read Water Cooler Finance: The Unrelenting Claw Of Bernie Madoff.

Related Articles
  1. Investing Basics

    5 Ways to Double Your Investment

    So if you want to go double, consider these five classic strategies to help turn your vision into a reality.
  2. Investing

    2 Common Ways to Misuse Target Date Funds

    The world of asset classes is just as complicated as taking vitamins. How much should you take of small caps? Intermediate bonds? Emerging market stocks?
  3. Mutual Funds & ETFs

    4 Mutual Funds Warren Buffet Would Buy

    Learn about four mutual funds Warren Buffett would invest and recommend to his trustee, and discover detailed analysis of these mutual funds.
  4. Stock Analysis

    4 Quick Service Restaurants for Your Portfolio

    Learn about the four quick service restaurants with attractive investment theses and growth prospects that can be valuable additions to your portfolio.
  5. Investing News

    4 Value Stocks Worth Your Immediate Attention

    Here are four stocks that offer good value and will likely outperform the majority of stocks throughout the broader market over the next several years.
  6. Mutual Funds & ETFs

    The 4 Best Buy-and-Hold ETFs

    Explore detailed analyses of the top buy-and-hold exchange traded funds, and learn about their characteristics, statistics and suitability.
  7. Investing

    How ETFs May Save You Thousands

    Being vigilant about the amount you pay and what you get for is important, but adding ETFs into the investment mix fits well with a value-seeking nature.
  8. Stock Analysis

    The Biggest Risks of Investing in Netflix Stock

    Examine the current state of Netflix Inc., and learn about three of the major fundamental risks that the company is currently facing.
  9. Mutual Funds & ETFs

    3 Fixed Income ETFs in the Mining Sector

    Learn about the top three metals and mining exchange-traded funds (ETFs), and explore analyses of their characteristics and how investors can benefit from these ETFs.
  10. Bonds & Fixed Income

    High Yield Bond Investing 101

    Taking on high-yield bond investments requires a thorough investigation. Here are looking the fundamentals.
  1. Why have mutual funds become so popular?

    Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic ... Read Full Answer >>
  2. What licenses does a hedge fund manager need to have?

    A hedge fund manager does not necessarily need any specific license to operate a fund, but depending on the type of investments ... Read Full Answer >>
  3. Can mutual funds invest in hedge funds?

    Mutual funds are legally allowed to invest in hedge funds. However, hedge funds and mutual funds have striking differences ... Read Full Answer >>
  4. When are mutual funds considered a bad investment?

    Mutual funds are considered a bad investment when investors consider certain negative factors to be important, such as high ... Read Full Answer >>
  5. What fees do financial advisors charge?

    Financial advisors who operate as fee-only planners charge a percentage, usually 1 to 2%, of a client's net assets. For a ... Read Full Answer >>
  6. Can your car insurance company check your driving record?

    While your auto insurance company cannot pull your full motor vehicle report, or MVR, it does pull a record summary that ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Purchasing Power

    The value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. Purchasing ...
  2. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  3. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  4. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  5. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  6. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!