Most investors are well aware that diversification is a key principle of investing, and that they should be careful not to put all their eggs in one basket. But not diversifying enough is still the first thing experts tend to cite when asked about common mistakes investors make in their portfolios. This is because diversification takes many shapes and forms, and it’s very easy to neglect at least one of them.
People don’t always hold enough diversifying assets, especially in proportion to their risk appetite. While bonds did not quite work as counterweights to equities in 2022, that does not mean this will always apply in the future, and there are other, alternative asset options such as infrastructure too. But even investors who aim for a diverse set of assets can become over-reliant on one scenario and end up with a collection of funds or shares leaning the same way, for example because they focus on certain themes or sectors, or they favour a certain style of investing.
Lack of diversification can easily happen at the style or geography level, but it can also happen for a single fund or stock. Laith Khalaf, head of investment analysis at AJ Bell, cites Scottish Mortgage Investment Trust (SMT) as an example of a popular fund that did extremely well for a long time, becoming an increasingly prominent portion of people’s portfolios in doing so. This increased risk, and many investors will have felt the impact when the trust started underperforming. Avoiding this “accidental” concentration is crucial when the fund in question has a specialist approach that makes it unsuitable as a core holding.