Episode # 22: Diworsification- Avoiding Overlap and Simplifying Your Portfolio

Wealth Decisions Podcast Transcript for Episode #- Avoiding Overlap and Simplifying Your Portfolio

Listen to this episode on Apple Podcasts or Spotify

Welcome to The Wealth Decisions Podcast, where each week I take 15 minutes or less to discuss crucial wealth decisions and mindset hacks to help you live a richer life.

I'm your host, Brian Muller, and I've been in the financial services industry for over 25 years, and I'm also a certified life and health coach.

And I have a passion for helping people make better decisions around their money and their life.

So for the sake of time, let's dive right into it.

In today's episode, we're going to be talking about de-worsification, how to avoid overlap and how to simplify your portfolio.

If you were to look up de-worsification in the dictionary, you're not going to find a definition because it's not actually a word.

But what de-worsification to me means is that you have too many investments, and many of those investments all have the same stocks in the top 10 holdings.

From time to time, I have a new client come to me, and when I analyze their portfolio, I find that they have anywhere from 25 to 40 different ETFs and mutual funds.

This is the very definition of de-worsification.

There's too many investments to keep track of, and many of them have the same stocks in the top 10.

So whether you're a seasoned investor or you're just starting out, understanding de-worsification can help you optimize an investment strategy and potentially improve your returns over time and allow you to simplify things to make it easier to stay on top of your finances and your portfolio.

So what we're going to be covering today is what is de-worsification and why it matters.

We're going to look at some of the common signs of an overcomplicated portfolio.

We're going to talk about the dangers of excessive de-worsification, some strategies to simplify your investment approach, and how to maintain a diversified portfolio while avoiding overlap.

The term de-worsification was actually coined by legendary investor Peter Lynch, and he referred to the process of adding investments to a portfolio in attempt to diversify, but instead you end up with a confusing, inefficient mix that actually increases risk and potentially reduces returns.

I think many investors fall into the trap of thinking that more is always better when it comes to diversification.

But what we're going to be talking about is effective diversification is about quality, not quantity.

So let's dive into some of the common signs that your portfolio might be suffering from diversification.

Number one, if you own individual stocks and you find yourself holding anywhere from 30 to 100 different stocks, it's likely that you might be duplicating some specific sectors within the sector that you're investing.

And it also makes it very difficult for you to stay on top of things and keep track of all those different individual stocks.

If you own multiple funds with similar objectives, for example, if you own several large cap growth mutual funds or ETFs that essentially track the same segment, then you probably have too many investments in that particular objective.

Number three, if it's difficult explaining your investment strategy, if you can't describe your investment approach or the purpose of each holding, your portfolio may be too complicated.

Number four, if your portfolio is underperforming the market pretty drastically, that means you probably have the wrong mix of investments or you have too many investments that are not tracking the different parts of the market.

Number five, an overly complex portfolio sometimes can mean that there's higher overall fees eating at your returns over time.

So make sure that you look at all the different fees that you're paying on the different mutual funds and ETFs and take a deep dive to try to minimize those without sacrificing returns.

And number six, there may be a lot of overlap in your holdings.

If you own multiple mutual funds or ETFs, check the top ten holdings.

Significant overlap can indicate some type of de-worsification.

There's no point in having three growth mutual funds and ETFs all with the same top ten holdings.

So let's look at some of the dangers of excessive de-worsification.

We all know that de-worsification is a fundamental principle of sound investing, but taking it too far can lead to several problems.

Number one, it can reduce your returns potentially.

By spreading your investments too thin, you might dilute the impact of your best performing investments.

Obviously, it increases the complexity of your portfolio.

The more investments you have, the harder it becomes to manage and rebalance your portfolio effectively.

This type of complexity can lead to maybe some oversight or mismanagement.

Number three, potentially there could be higher costs.

The more holdings often means more transactions and potentially higher fees, which can eat at your returns over time.

Number four, an overly diversified portfolio might give you the illusion of safety while actually potentially increasing your risk due to lack of focus and oversight.

You might think you're well protected because you have more holdings, but if you don't understand all your holdings, you could be exposed to some unforeseen risks.

It's also very difficult to track performance.

With too many holdings, it becomes challenging to understand which investments are driving your returns and which investments are dragging them down.

So let's explore some strategies for simplifying your investment portfolio.

If you currently have 10 or 15 or 20 different holdings, you could simplify your portfolio down to as little as 5 to 7 and still have broad diversification.

For example, you could use a total US stock market fund that covers small, mid and large cap.

You could have an international stock fund to cover developed markets.

You could have an emerging markets ETF.

You could have a couple fixed income ETFs to cover intermediate term type fixed income investments or short term fixed income investments.

Take a look at some of your holdings and think about consolidating similar holdings.

So review your portfolio for funds or ETFs with similar objectives.

And just consider keeping the one with the best performance and the lowest fees.

Number three, you could implement a core satellite approach.

This strategy involves building the core of your portfolio with broad-based, low-cost index funds and then adding a few carefully selected individual stocks or specialized funds as what they call satellites for potential outperformance.

Number four, you could set a limit on the amount of individual stocks you're going to own.

If you enjoy picking stocks, consider limiting them to a small percentage of your overall portfolio, maybe 5 to 10%.

This will just allow you to pursue some active strategies without risking your entire nest egg.

Number five, you want to regularly review and rebalance your portfolio.

Set a schedule to review your portfolio perhaps quarterly or semi-annually.

This just helps you stay on top of your investments and make any necessary adjustments.

So the whole idea of maintaining a diversified portfolio while avoiding this concept of de-worsification is to build a portfolio that covers all the areas of the market globally in a simplified way.

You don't need five different large cap growth ETFs or mutual funds.

You don't need three different mid cap funds.

You don't need two different small cap funds.

You don't need five different international and emerging market funds.

You can make a very diversified portfolio using seven to nine different low cost ETFs and mutual funds that covers all the areas of the market and simplifies things to keep track of your portfolio and make it easier to rebalance over time.

You don't want to ignore international investments or emerging market investments.

You don't want to ignore bonds just because somebody told you bonds are boring or they're not for growing your wealth.

Bonds are an important part of a portfolio to help protect your portfolio in times of trouble.

It depends on your stage in life.

The closer you are to retirement, the more you're going to want in fixed income and conservative investments that can help buffer your portfolio when we do have downturns.

We will have market downturns.

About every one and a half years, we have a 10% correction.

About every four years, we have a 20% correction.

You need to be prepared for those and have the right mix of investments for your stage in life and risk tolerance.

Just be wary of the flavor of the month type investments.

It's easy to be tempted by the latest investment trends, but, you know, adding these to your portfolio without careful consideration on whether it fits in your mix for your stage in life and is going to help you reach your financial goals is a common mistake I see people make.

Avoid the 3X leverage ETFs out there that show these amazing track records because it uses leverage to enhance returns.

Avoid bear market ETFs and strategies that go against the market.

You don't need all those types of investments to build your wealth.

Should you have cryptocurrencies in your portfolio?

Depending on your stage in life, maybe some cryptocurrency in your portfolio, but I would limit it to 5% or less if you do want exposure to the cryptocurrency market.

But always consider how a new investment fits into your overall strategy.

Again, asset allocation, like I talked about last week in Episode 21, is the most important thing to focus on.

Your overall mix of stocks, bonds, and cash is the most important thing that you can determine.

And that's all based upon your risk tolerance.

It's more important than the individual securities you choose or ETFs.

Having the right mix is crucial to help you reach your long-term goals and to stay invested through all the difficult periods that you'll face throughout your investing journey.

Remember that the goal of diversification is to create a portfolio that can weather various market conditions while aligning with your financial goals.

It's not about having the most investments, but about having the right investments.

By simplifying your portfolio and avoiding diversification, you can potentially reduce costs, improve your returns, and most importantly, gain a clearer understanding of your investment strategy.

And that understanding can lead to more confident decision making and better long-term results.

Just always remember that investing doesn't need to be overly complex to be effective.

A simple, well-thought-out approach can yield better results than a complicated one.

As you review your own portfolio, consider where you might be able to simplify without sacrificing true diversification.

And if you don't know where to start when it comes to analyzing your portfolio, I do have some new services where you can hire me on a one-time basis or an hourly basis depending on how complex your portfolio is.

And I'll take a deep dive using Nitrogen Wealth and we'll analyze your portfolio to discover if it's truly diversified, overly diversified, where the overlap is, what you're paying in fees, and how we can improve your portfolio going forward.

You can find out more information on the one-time portfolio analysis or the hourly advice platform for a portfolio analysis and investment recommendations in the description of this podcast.

So that's it for today's episode, Diversification, Avoiding Overlap and Simplifying Your Portfolio.

Listen to this episode on Apple Podcasts or Spotify


-Brian D. Muller, AAMS® Founder, Wealth Advisor

Momentous Wealth Advisors in a fee-only fiduciary advisory firm

Disclaimer: This material is for informational purposes only and should not be construed as investment advice. Past performance is not indicative of future results. Investors should make investment decisions based on their unique investment objectives and financial situation. While the information is believed to be accurate, it is not guaranteed and is subject to change without notice.

Investors should understand the risks involved in owning investments, including interest rate risk, credit risk and market risk. The value of investments fluctuates and investors can lose some or all of their principal.

Always consult with a qualified financial professional before making any investment decisions.