Is overdiversification necessarily bad?

#1
One well-known advice is: diversification is good but over-diversification is bad.
I have doubt about this. Consider two examples:
case-1
Sticking to the advice, someone decided to invest Rs4000 in only one large cap fund, DSPBR top100 equity. After 3 years, return is about 10% i.e., Rs400.

case-2
another person decided to diversify a bit and invested in two large cap funds 3 years back: Rs2000 each in DSPBR to100equity and HDFC top200 (it has small midcap bias, but ignore that). After 3 years, returns are 10% and 14% resp. So total return is: Rs200+Rs280=Rs480

So in second case, due to diversification, return is more. Of course if in case-1, one if one invested entirely in HDFC Top200 then return would have been maximum. Since one can not predict future and past performance of a fund is not an absolute indicator of future performance, by diversification as in case-2, the return is averaged.

However everybody would call strategy in case-2 an overdiversification. But is it really so bad? (Of course I do not mean blind overdiversification but overdiversification in carefully chosen select funds)
 
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sumeetsj

Well-Known Member
#3
Diversifcation is good.

Never put all your eggs in one basket.

But anything done in excess (over-diversification) can do no good.

Diversifying for the sake of diversification can only yield mediocre returns.

If into funds please stay invested for minimum 3-5 years+
 
#4
You are comparing 2 funds against one. If you try repeating the exercise with 3,4,5 or say 10 funds, you will observe that the returns will be around 10% only.

This is due to the fact that on an average some funds would overperform and some would underperform. It is best to stay invested in about 5-7 funds at a time. This way, you can monitor them closely and switch to better funds if needed. If you hold too many funds, it would be quite a task.
 
#5
Thanks for your responses.

I think my point was not clearly expressed. As an example, I had shown what happens if one chooses to invest in two large cap funds instead of one. Large cap fund is just one part of a portfolio. there would be mid+small cap funds (and possibly ELSS) too. Now if one chooses say three good funds in each category, then total number of funds become six (or more). On the other hand if I choose just one really good fund in each category then total number of funds is two (at least). Anyway I agree with the last reply that too many funds will not in general perform equally well so that one should limit no of funds or in other words avoid overdiversification. Also one must periodically check fund performance to check if change of fund is necessary.
 

4xpipcounter

Well-Known Member
#6
I'm a little different in my views, and this is no exception.

First, some facts. I trade forex, and it is impossible to diversify in forex. I always like to back up my bold statements with facts, so here goes.
All forex pairs are related by virtue of their algebraic relationships. As an example, take the EUR/NZD, and multiply it by the NZD/USD. The product will always be the price on the EUR/USD. In other words, if both of the aforementioned are going UP, then the EUR/USD has to go UP. Having that you could make an equation that would connect every forex pair. In conclusion, I cannot diversify, because it is impossible, because of the mathematical interrelationships between all the pairs. That's fact. Now, to the JMO (just my opinion):

All markets move with a predictable cyclical element. As an example, the drop from 6000's by Nifty was predictable, the bounce from circa 5222 was predictable, and the current sideways action is also predictable, and expect more sideways action from it in coming days. These cycles all contain a tenure, which is a range of circa 26-32 candles. Therefore, if you have 2 markets in an uptrend, most likely the reversal is going to happen the circa same time for both. As an example, I predicted the reversal for Hang Seng (Didn't know the market existed until someone asked me to look into it.), and the NZD/USD. They are both unrelated, but their northern cycles were both on life support, and it is evident now by looking at both of their charts.

At the risk of sounding conceited, but I will speak for all of us. I have 3 winning trades up now, and none are losing. I don't want to diversify there either. The reversals for the CHF/JPY and GBP/JPY were predictable. The USD/JPY is also moving south. See the similarity?

It's a little different view. A little different perspective, but I wanted to share it.
 
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