Diversification of portfolio

Anyone who has been investing would know what a portfolio means and what are the typical assets an individual would have. He would also know that diversification of the portfolio is important, however I am writing this one to re-iterate the fact that diversification is important, but over diversification is not.

Let's first understand the aspects of assests that need to be understood well, which are liquidity, return and risk. 

Liquidity: Normally there are following types of assests: fixed assets like property or land and liquid assets like cash or savings account and finally equities/funds etc. which fall in between the spectrum of these two extreems. 

Return: Return is typically measured as the Annual rate of return for the given asset. For instance cash has 4% return, FDs have 7% returns, Debt funds offer mostly a little better and equities even better for longer horizon and then properties some time provide staggering returns for investors. However, no one should ever consider only return for an asset alone. I say this because typically the moment the potential for the return increases it does come along with increased risk and volatility. 

Risk: Definition of risk is basically the volatility of returns for an asset, and this volatility sometime ends up eating from your principal as well. Its not always feasible to measure the risk for the investment. You should have a mitigation plan for this aspect, and one of the mitigation approach is Diversification. 

Note that some structured investments like mutual funds and equities do have alpha values, that help you determine the risk adjusted returns from these investments. But then there are property investments which are very local to the nature, location and type of property and cannot be so generalised.

So, in summary diversification of portfolio helps us average out excessive volatility in any given asset and help provide stability to the whole portfolio. 

However, over diversification simply adds up to the hassles of maintenance of the assets rather than helping a lot.

 A typical example would be of an individual investing in top 5 mutual funds of say mid-cap category. Now, each of those funds are by nature diversified and they all end-up investing in same universe of equities and hence there is no much sense behind holding more than 1-2 funds of a specific category. 

Another would be holding too many properties, property consumes a huge quantum of your money and hence more than one would really skew your portfolio towards a particular type of asset. And then you would take years to balance, or you may never be able to balance the risk and volatility that might come from this kind of asset. 

I think with all this I have made my point on Diversification

• The need of diversification
• And how not to overdo it 

So, the golden rule is "too much of anything is bad", you have not heard it first time :)