How to Check Portfolio Diversification
Quick Answer
To check portfolio diversification, review four key areas: asset class mix (stocks, bonds, cash), sector exposure (no single sector over 25-30%), geographic spread (domestic vs. international), and individual position sizes (no single stock over 5-10% for most investors). A well-diversified portfolio spreads risk across these dimensions.
The 4-Point Diversification Checklist
Use this simple checklist to evaluate your portfolio: (1) Asset Classes—do you have a mix of stocks, bonds, and cash appropriate for your timeline? (2) Sectors—is any single sector more than 25-30% of your stock allocation? (3) Geography—do you have exposure to both domestic and international markets? (4) Position Sizes—is any single holding more than 5-10% of your total portfolio?
Why Asset Class Diversification Matters
Different asset classes behave differently in various market conditions. Stocks offer growth potential but with volatility. Bonds provide stability and income. Cash preserves capital. A portfolio with only stocks may drop 30-50% in a bear market. Adding bonds and cash can reduce that drawdown significantly, though it may also reduce long-term returns.
Checking Sector Concentration
Many investors unknowingly concentrate in certain sectors. If you own several tech stocks plus a tech-heavy index fund, you might have 40-50% in technology without realizing it. Review each holding's sector classification. The S&P 500 has 11 sectors—a diversified stock portfolio typically has meaningful exposure to at least 5-6 of them.
Geographic Diversification
U.S. stocks have outperformed international stocks recently, but that hasn't always been true. International stocks can provide diversification benefits because different economies don't move in lockstep. A common starting point is 60-80% domestic and 20-40% international, but the right mix depends on your situation.
Individual Position Limits
Even great companies can fall. Holding too much in any single stock exposes you to company-specific risk. A general guideline is keeping individual positions under 5-10% of your portfolio. This is especially important for company stock from employer compensation—it's easy to become over-concentrated without noticing.
Frequently Asked Questions
How diversified should my portfolio be?
There's no single answer. A common approach is to own at least 20-30 individual stocks across multiple sectors, or use broad index funds that provide instant diversification. The key is spreading risk so no single investment can significantly damage your portfolio.
Can I be too diversified?
Yes, over-diversification (sometimes called "diworsification") can lead to returns that closely match the market while adding complexity. If you own 100+ individual stocks, you might achieve similar results with a few index funds at lower cost.
How often should I check diversification?
Review quarterly or when you make significant changes. Market movements can shift your allocation—a stock that grows faster than others will become a larger percentage of your portfolio over time.
Do ETFs automatically provide diversification?
ETFs provide diversification within their category, but you can still be concentrated. Three tech ETFs don't diversify you across sectors. Check what each ETF actually holds and look for overlap.
Educational Only / Not Investment Advice: This content is for educational purposes only and does not constitute investment advice, a recommendation, or an offer to buy or sell any securities. Investment decisions should be based on your individual circumstances and made in consultation with a qualified financial professional. Past performance does not guarantee future results.
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