Under and Over Diversification
If you overdiversify, meaning you spread your risks around to too many different stocks, you cannot beat the market average.
A more recent study, from 2004 through 2008, revealed that 66.21 percent of all managed stock funds in the United States reported results worse than the overall market (measured against the S&P Composite 1500 Index).
Key PointIt surprises some people to hear that most mutual funds have done worse than the market averages. This happens for many reasons, among them the need to overdiversify.
The overall report of 66.21 percent of all funds means that only about one-third of funds outperformed the overall market. This is due to overdiversification as one important factor in the outcome. In selecting a mutual fund for those who decide to choose that route, past performance is important but so is asset size.
Diversifying with mutual funds might seem a logical and easy step. But be aware that smaller funds have greater flexibility than extremely large ones and can move money around more easily.
Buying funds is one way to diversify within the stock market. You can mix directly owned stocks with shares of mutual funds and ETFs. You can also mix between value investments and speculation, as well as stocks in between. Volatility levels is a sound test of market risk, so diversifying by levels of volatility is one final way to spread capital around.
By Michael C. Thomsett