Smart Diversification

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“Wide diversification is only required when investors do not understand what they are doing”
Warren Buffet
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No one will argue that diversification is required.  The question is how much.  Most of the time, the answer is too much.  In order to optimize the reward/risk ratio, it is imperative to apply some “science” to portfolio diversification.

One concept that is often forgotten is that the specificities of an investment strategy is a key input to the diversification answer.  For example, in the case of TQI, some strategies like ETF Momentum will use diversified investment products (ETF) since it has minimal negative impact on the overall performance but reduce overall risks. On the other hands,  Hyper-Growth will have very limited diversification to capture the high returns.  In the case of Hyper-Growth, the risk is mitigated by allocating only a small portion of the overall portfolio.

The following graph provides a very clear view of the limited benefits associated with over-diversification:

 

Sources:
Over-Diversification in Mutual Funds
The Dangers Of Over-Diversifying Your Portfolio

Disclaimer: For general information purposes only.

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