The big mistake that young investors make when it comes to diversification

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July 12 2021
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Is it possible to be too diversified? What are common things that younger investors should watch out for when it comes to thinking about diversification?

The big mistake that young investors make when it comes to diversification

These days, young investors are more likely to be familiar with the concept of diversification than not.

However, determining the right level of diversification can be a challenge for those just finding their feet in the market.

According to Wealth Within chief analyst Dale Gillham, it is very common for investors to overdiversify given that the majority don’t really understand the true meaning of the concept.

Mr Gillham said that while many investors are able to grasp the idea of spreading risk around rather than concentrating all of their funds in one pool, they often fail to understand or define the concept of risk.

He said that there are two different types of risk that investors need to be aware of, systemic risk and specific risk.

“In order to construct a portfolio correctly, investors need to understand both of these concepts,” he said.

“Failure to do so means that investors are taking higher risks than they need to, which I refer to as de-worsification, which results in average returns at best.”

Mr Gillham said that the ideal balance between risk and reward in a portfolio is to hold between eight and 12 different stocks.

“I say this because you don’t get double the benefit of holding 20 stocks than you do from holding 10 and you certainly don’t get three times the benefit from holding 30 stocks. Instead, all you get is more risk and a mountain of paperwork.”

He said that while younger investors may hold smaller portfolios, it’s easy for them to run into trouble.

While apps make it easier than ever for investors to build out a grab-bag of shares in various companies, Mr Gillham warned that this can reduce returns as any one position will have very little effect on an overall portfolio.

“The trick is to hold fewer stocks with more invested in each, as the movements of stocks within the portfolio will have a greater impact on the portfolio return,” he said.

About the author

Fergus is a journalist for Momentum Media's nestegg and Smart Property Investment. He likes to write about money, markets, how innovation is changing the financial landscape and how younger consumers can achieve their goals in unpredictable times.

About the author

Fergus is a journalist for Momentum Media's nestegg and Smart Property Investment. He likes to write about money, markets, how innovation is changing the financial landscape and how younger consumers can achieve their goals in unpredictable times.

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