Avoiding "Diworsification"

Diversification is a core principle of portfolio management, but there is such a thing as too much of a good thing. The term "diworsification" describes the pitfall of over-diversifying—adding so many funds or assets that you inadvertently reduce your portfolio's effectiveness. When you invest in multiple funds with similar holdings, you may believe you are lowering risk, but in reality, you might be concentrating in the same underlying assets. This can lead to higher fees, redundant exposures, and a diluted potential for outperformance, all while providing little additional protection against downturns.

A simple way to measure how much your portfolio's funds overlap is with this formula:

If two funds each hold many of the same stocks, your overlap percentage will be high, signaling potential diworsification.

Consider a portfolio that holds the following three funds:

• S&P 500 Index Fund;
• Total U.S. Stock Market Fund;
• Large Cap Growth Fund.

At first glance, this may seem diversified. However, all three funds heavily invest in large U.S. companies like Apple, Microsoft, and Amazon. The overlap is significant—these funds often own the same stocks in similar proportions. The drawbacks of this excessive overlap include:

• Paying multiple layers of fees for essentially the same exposure;
• Gaining little additional diversification benefit;
• Potentially missing out on other asset classes or sectors that could improve your risk-return balance.

In practice, diworsification can leave you with a portfolio that is more complicated, more expensive, and less effective than a simpler, well-constructed mix.