Diversification Myths That Could Be Costing You Money

Last week, I met with a successful physician who proudly showed me his “diversified” portfolio of twenty different stocks. The problem? Every single one of those stocks could drop 20% in a single day of market panic. That’s not true diversification – it’s just owning a lot of the same type of risk.

This situation comes up more often than you might think, and it highlights an important truth about investing: Understanding diversification in theory isn’t the same as implementing it effectively in practice.

Let me share what I’ve learned about diversification after fifteen years of helping professionals protect and grow their wealth.

Beyond the Basics: What Really Matters

Think of diversification like building the foundation of a house. Get it right, and everything else becomes more stable. Get it wrong, and even the best materials won’t prevent structural problems.

Here’s what actually matters: Different types of investments respond differently to market events. During the past decade, U.S. large-cap stocks have been the overall winners. But they weren’t at the top every year. Sometimes small-caps led the way. Other times, it was real estate or international markets.

This rotation of leadership creates powerful opportunities for building resilient portfolios. When you own assets that respond differently to market conditions, you create multiple paths to reach your goals.

The Hidden Costs of Poor Diversification

I recently reviewed a portfolio for a corporate executive who thought she was well-diversified. She owned multiple target-date funds across different companies, essentially duplicating the same positions while paying extra fees. After analyzing her holdings, we found she was paying nearly double the fees she needed to, all while missing key areas of the market that could have improved her portfolio’s stability.

We consolidated her holdings, reduced her costs, and actually improved her diversification by adding asset classes she was missing entirely. The result? A portfolio that not only saved her money on fees but also showed more stable performance during market volatility.

Three Questions to Test Your Diversification

Want to check if your portfolio is truly diversified? Here are three key questions to consider:

First, do you own anything besides stocks? Bonds, real estate, and other assets often move differently than stocks, providing stability when markets get rocky. This isn’t just about owning bonds for the sake of owning bonds – it’s about understanding how different assets can work together in your portfolio.

One client came to me worried about market volatility impacting his retirement plans. By adding specific types of bonds and real estate investments to his all-stock portfolio, we created a more balanced approach that helped him stay invested during market downturns while still capturing growth opportunities.

Second, do you own companies of different sizes? While large companies grab headlines, smaller companies often thrive under different economic conditions. Last year, I helped a client who was heavily concentrated in tech giants spread their risk across mid-sized and smaller companies. When tech struggled, these positions helped cushion the impact.

Understanding how different sized companies complement each other makes this strategy powerful. Smaller companies often respond differently to economic changes, providing growth opportunities that larger companies might have outgrown.

Third, have you gone too far? One attorney I work with came to me with thirty-seven different mutual funds. After analysis, we found he was paying extra fees to own essentially the same investments multiple times. We simplified his portfolio down to eight core positions that provided the same diversification at lower cost.

This is a common challenge I see with self-directed investors – the idea that more positions automatically means better diversification. In reality, effective diversification is about quality over quantity.

Common Myths About Diversification

Through years of working with clients, I’ve encountered several persistent myths about diversification that need addressing:

“It eliminates risk.” No – it helps manage risk, but can’t eliminate it. The goal isn’t avoiding all risk; it’s taking intentional risks aligned with your goals. I recently worked with a client who was frustrated that his diversified portfolio still dropped during a market correction. We had a valuable discussion about the difference between eliminating risk (impossible) and managing it effectively (achievable).

“It’s set and forget.” Markets move, changing your portfolio’s composition. A portfolio that starts with 60% stocks might drift to 70% during a bull market. Regular rebalancing keeps your risk level aligned with your plan. This isn’t just theory – I’ve seen portfolios drift more than 15% from their targets during strong markets, fundamentally changing their risk profile without the owner realizing it.

“Multiple advisors equals better diversification.” Unless your advisors specialize in truly different areas (like private equity), you’re likely duplicating positions and increasing costs. I recently helped a client consolidate three advisor relationships that were essentially creating three slightly different versions of the same portfolio. The consolidation not only reduced costs but also improved tax efficiency and made their strategy more coherent.

Making Diversification Work for You

Remember – the best investment strategy isn’t necessarily the one that looks perfect on paper. It’s the one you can stick with through market turbulence. A properly diversified portfolio won’t always top the performance charts, but it should give you confidence that you can weather market storms while staying on track toward your goals.

The key is understanding that diversification isn’t about maximizing returns in any given year – it’s about creating a portfolio that can deliver reliable progress toward your goals regardless of market conditions. When done right, it’s like having multiple paths to your destination. If one path becomes blocked, you have alternatives that can keep you moving forward.

Think about your own portfolio. Are you truly diversified, or do you just own a lot of similar investments? Are you maintaining your target allocations through regular rebalancing? Most importantly, does your current strategy give you the confidence to stay invested when markets get volatile?

These aren’t just theoretical questions – they’re the foundation of building a portfolio that can help you reach your long-term financial goals while letting you sleep well at night.

Your portfolio might be working harder than it needs to. I regularly help professionals spot gaps and opportunities in their portfolios that they might have missed. 

If you’d like to explore what this could look like for your portfolio, let’s talk.