When investors hear the word diversification, they often think of one thing: owning a lot of investments.

 

If you own 20 different funds, stocks, or other investments, your portfolio must be diversified, right? Not necessarily.

 

True diversification isn't about how many investments appear on your statement. It's about understanding what you actually own, where your risks are concentrated, and whether your investments are likely to respond differently as market conditions change.

 

 

More Investments Don't Always Mean More Diversification

Imagine an investor owns five different mutual funds. At first glance, that sounds reasonably diversified. But when you look inside those funds, you may discover that several own many of the same large companies or have similar exposure to the same sectors of the market.

 

The names on the statement are different. The underlying risks may not be. This is why looking beneath the surface is so important.

 

When evaluating a portfolio, it can be helpful to consider exposure across areas such as:

• U.S. and international markets
• Large, mid-sized, and smaller companies
• Growth and value styles
• Stocks and fixed income
• Industries and economic sectors
• Shorter- and longer-duration bonds
• Cash and other investments where appropriate

The goal isn't to own a little bit of everything simply for the sake of owning it. It's to understand what role each part of the portfolio plays.

 

 

 

Beware of Investment Overlap

One of the easiest ways for a portfolio to become unintentionally concentrated is through fund overlap.

 

Suppose an investor owns several U.S. large-cap funds. Each may have a different name and investment strategy, but when you examine the underlying holdings, many of the same companies could appear repeatedly.

 

The investor may think they've spread their money across multiple strategies when, in practice, their portfolio may depend heavily on the performance of a relatively small portion of the market.

 

That isn't necessarily bad. There may be good reasons to emphasize a particular area.

 

The important question is whether that concentration is intentional.

 

 

 

Diversification Is About Different Types of Risk

Stocks aren't the only place where diversification matters.

 

Consider bonds. Two bond funds can behave very differently when interest rates change. Duration, credit quality and the types of bonds held can all influence how a fixed-income investment responds to changing market conditions.

 

The same concept applies across an entire portfolio. An investor might hold U.S. stocks, international stocks and bonds so that the success of the financial plan isn't dependent on one particular part of the market performing well at exactly the right time.

 

Diversification won't eliminate risk or guarantee against investment losses. What it can do is help prevent one investment, sector, style or market event from having an outsized influence on the entire portfolio.

 

 

 

Your S&P 500 Fund May Already Own Hundreds of Companies

Here's another reason investment count can be misleading.

 

Someone who owns a broad-market fund technically owns exposure to many individual companies through that single investment. Meanwhile, someone with 20 individual investments concentrated within one industry could actually have much greater concentration risk.

 

So asking, “How many investments do I own?” doesn't tell us very much on its own.

 

Better questions include:

• What companies and sectors am I actually exposed to?
• Where do my funds overlap?
• How concentrated is my portfolio?
• What risks am I taking?
• Do different parts of my portfolio serve different purposes?
• Does the overall allocation still match my goals, time horizon and risk tolerance?

Those questions tell us much more about diversification than simply counting investments.

 

 

 

Diversification Should Have a Purpose

There's another side to this conversation: more diversification isn't automatically better.

 

Adding another fund simply because it's different can make a portfolio more complicated without necessarily making it better.

 

Every investment should have a reason for being there. For one investor, that could mean balancing growth potential with investments designed to provide income and stability. For another, taxes, retirement withdrawals or a concentrated stock position may influence how the portfolio is constructed.

 

That's why portfolio construction should begin with the investor, not the investment.

 

 

 

Look Under the Hood

A well-diversified portfolio isn't defined by the number of lines on an investment statement.

 

It's defined by what those investments collectively own and, more importantly, how they work together.

 

At Evergreen Wealth, we believe good portfolio management requires looking beneath the surface. Understanding underlying holdings, asset classes, sectors, investment styles, risk characteristics and how each investment contributes to the overall strategy can provide a much clearer picture than performance alone.

 

Because you can own 20 investments and still be concentrated. And sometimes, a thoughtfully constructed portfolio with fewer investments can be far more diversified than one with a long list of holdings.

 

The goal isn't to own more. It's to own investments that work together toward your financial goals.