The Hazards of Over-Diversification In Your Investment Advice

investDavid Fabian:  One thing I have learned over the course of my career is there are never any shortage of opinions or strategies on how you should be investing your nest egg.  Everywhere you look there are hedge funds, mutual funds, ETFs, advisors, newsletters, insurance companies, and other fringe “experts” touting their methods. 

There is no doubt that each approach will have their own benefits and drawbacks.  Opportunities and risks will be characterized by security selection, position size, timing, and costs.  However, the problem that many investors run into is when they try to implement several divergent paths simultaneously.

I had an investor email me the other day and say that they are subscribing to several newsletters in tandem with placing multiple accounts with different investment advisors.  He wanted to know more about how we use ETFs – in effect shopping for one more opinion on what he should do with his money.

I know his intentions were quite genuine.  He is likely thinking that this structure is highly diversified and allows him to cover numerous bases with his investment portfolio.  However, the reality is that he is trying to drink from a fire hose of information and absorbing opinions from a wide range of conflicting sources.

Some questions immediately come to mind when I think about this common dilemma:

  1. How do you decide the weighting of each advisors’ opinion or strategy?
  2. What systems are you actually using and which ones are just there for “market research”?
  3. Are you increasing your overall costs by implementing all these services continually?
  4. Do each of these services enhance your total return or are they just giving you something to do?
  5. Are you just needlessly searching for the holy grail of strategists that will outperform in every market environment? (hint: they don’t exist)

In any group of 4 or 5 advisors, there are probably going to be at least one that is taking a contrarian viewpoint and possibly even implementing that in their recommendations.  That means you are likely absorbing opposing views that will erode your confidence in sticking with a simple and reliable plan.

Let me tell you from experience what will happen.  You see one guy tell you to buy bonds as a core allocation and shock absorber for your portfolio.  The next guy tells you that rising rates are going to destroy the foundation of the American economy.  The only reasonable course of action then is to do absolutely nothing – and you will.

Sitting in cash fretting about which person to believe and then only likely implementing the correct answer long after the move has been made.  The funny thing is that both of these recommendations will likely be right at some point.  The problem is that we only know which one (and when) with the clarity of hindsight.

Or worse, you end up going long bonds in one account and short bonds in another account, which effectively offsets both trades.  There is nothing quite like the experience of paying to go nowhere.

The same can be said of stocks as well.  I read three articles last week talking about how consumer staples stocks were risky because of their high relative valuations.  This morning I woke up to an explanation of how consumer staples are historically some of the best stocks to own during the summer months.  It’s that kind of conflicting advice that permeates this industry.  One argument is fundamentally driven, while the other is data-driven.  Both have their own merits.  Who do you believe?

There Is An Easier Way

My best advice is to pare down the number of advisors with a substantial influence on your portfolio. 

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