BMO Financial Group

BMO Financial Group
BMO Bank of Montreal

BMO Bank of Montreal

April 27, 2012 08:00 ET

BMO InvestorLine: Too Much of a Good Thing? The Dangers of Having an Over-diversified Investment Portfolio

- While diversification is an important tool to reduce risk, there are limits to its usefulness

- Holding more than 30 stocks can reduce the benefits of diversification; opting for 10-30 holdings should provide good diversification while reducing risk

- Avoid duplication in Canadian equity mutual funds by choosing only one or two mutual funds with 30 or more holdings each

- BMO provides advice on how to structure investments

TORONTO, ONTARIO--(Marketwire - April 27, 2012) - While investors are often counselled that diversification is critical for investing success, can one's investments be over-diversified? According to BMO InvestorLine, the answer is yes.

How Many Stocks Should a Portfolio Contain?

A diversified portfolio - one with a mix of investments spread across several sectors - reduces volatility without lowering expected returns. By adding a number of stocks to your portfolio, you gradually lower your risk. However, according to Cesar Rainusso, Vice-President at BMO InvestorLine, holding more than 30 stocks in a portfolio can reduce the benefits of diversification by eliminating the investment risk essential for strong returns.

"Holding too many individual stocks can lead to added transaction costs without actually lowering investment risk," said Mr. Rainusso. "It may be more efficient simply to select about 30 companies covering a range of sectors, such as financials, utilities, technology and healthcare."

While there is no single optimal number of stocks one should have in an investment portfolio, many experts would suggest that between 10 and 30 stocks should provide an investor with some level of diversification and the probability of reduced risk.

What's the Optimal Number of Mutual Funds?

Serge Pépin, Vice President, Investment Strategy, BMO Global Asset Management, notes the strategy can be different for mutual funds; "Canadian equity mutual funds tend to have similar holdings, including large positions in the banks and resource companies that dominate our market. This overlap adds cost and complexity to a portfolio."

Mr. Pépin suggests that it may be more economical to hold one or two Canadian equity mutual funds, each with 30 or more names.

Holding too many mutual funds of a similar nature can also reduce the likelihood of an outperforming portfolio. If similar funds with the same holdings are weighted differently, the fund managers may be working at cross-purposes.

"To avoid over-diversification with mutual funds, it's wise to choose funds with few redundant holdings and with complimentary strategies," said Mr. Pépin. "This way you ensure you get all of the risk reduction that comes from diversification without diluting the benefits."

BMO provides advice on how to structure an investment portfolio:

  • Time and Risk: One key approach to any investment program is the creation of proper asset allocation. This should take into consideration an investor's time horizon, risk tolerance and investment goals and aspirations.
  • The Four Building Blocks: A portfolio should include the four major blocks - a fixed income portion (to protect the downside), and well-diversified Canadian, U.S. and international equity blocks to provide you with growth.

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