Imagine you're at the world's most incredible all-you-can-eat buffet. The chefs have prepared a dozen truly spectacular, five-star dishes. There's a perfect filet mignon, a delicate lobster thermidor, and a rich, truffle-infused risotto. But next to them are hundreds of other, more average options: lukewarm hot dogs, soggy pizza, bland macaroni and cheese, and wilting salads. A wise diner would take generous helpings of the few truly exceptional dishes, savoring each one. This is concentration. Another diner, paralyzed by the fear of missing out, decides the “safest” strategy is to take a tiny spoonful of everything. They pile their plate high with 200 different items. The filet mignon is there, but its flavor is lost, buried under a scoop of Jell-O and a dab of mystery casserole. The end result? A confusing, lukewarm, and ultimately unsatisfying mush. The diner has experienced the best the buffet has to offer, but they can't taste it. This is over-diversification. In investing, it's the act of spreading your capital across so many different stocks (or assets) that you effectively neuter your ability to generate returns that beat the market average. It's often born from a misunderstanding of diversification, which is a crucial and healthy practice. Good diversification is about not putting all your eggs in one basket. Over-diversification is about owning so many baskets that you can't keep track of your eggs, and most of the baskets are filled with mediocre, low-potential investments anyway. It's the point where you trade the potential for exceptional returns for the certainty of average ones, all while creating a portfolio so complex you can no longer manage it effectively. The legendary investor Peter Lynch coined a perfect term for this: “diworsification.”
“Wide diversification is only required when investors do not understand what they are doing.” - Warren Buffett
To a value investor, over-diversification isn't just a suboptimal strategy; it's a philosophical contradiction. The entire discipline of value investing is built on a foundation of deep research, independent thought, and acting decisively when a rare opportunity presents itself. Over-diversification undermines every one of these principles.
For a value investor, the goal isn't to own the entire haystack in the hopes of finding a needle. The goal is to do the work to find the few, rare needles and then buy the needles.
Avoiding over-diversification isn't about finding a single “magic number” of stocks to own. It's about adopting a mindset focused on quality over quantity. The oft-cited range of 15 to 30 well-chosen stocks is a useful guideline for most individual investors, but the real test is one of knowledge and conviction.
Before you worry about numbers, apply this simple qualitative filter to every stock you own. Could you sit down with a bright ten-year-old and, in three minutes, explain:
If you stumble, hesitate, or rely on jargon, you don't understand the business well enough. This is a potential candidate for “pruning” from your portfolio. A portfolio where you can pass this test for every holding is a portfolio built within your circle_of_competence.
A position that is too small cannot meaningfully contribute to your returns. A 0.5% weighting in a stock is investment “clutter,” not a real investment. As a general rule, consider if each of your positions is large enough to “move the needle.” For many, this means a minimum position size of 2-3% and a maximum of 10-15% of the total portfolio value. This forces you to have high conviction, as each decision carries real weight. If you're not confident enough to invest at least 2% of your portfolio in an idea, you should probably question whether you should invest in it at all.
Take a hard, honest look at everything you own. Create a simple table and categorize each holding. This exercise will shine a bright light on the “weeds” in your investment garden.
| Company Name | My Conviction (High/Med/Low) | Do I Understand It? (Yes/No) | Action (Keep/Review/Sell) |
|---|---|---|---|
| Steady Brew Coffee Co. | High | Yes | Keep |
| Flashy Tech Inc. | Low | No 1) | Sell |
| Old Reliable Utilities | Medium | Yes | Review 2) |
| Complex BioPharma | Low | No 3) | Sell |
| Global Megacorp | High | Yes | Keep |
The goal is to methodically eliminate the “Sell” candidates—the ones you don't understand or in which you have low conviction. This frees up capital to add to your high-conviction “Keep” ideas, thereby concentrating your portfolio around your best thinking.
There is a simple, brilliant solution for investors who want the diversification of owning hundreds or thousands of stocks without the illusion of being a stock-picker: buy a low-cost index_fund. An S&P 500 index fund, for example, gives you exposure to 500 of America's largest companies at a tiny management fee. This is a perfectly respectable strategy. Over-diversification is the act of trying to build a worse, more expensive, and less efficient version of an index fund yourself. Choose one path: be a concentrated stock-picker or be a passive indexer. The worst results often come from trying to be both at the same time.
Let's illustrate the concept with two hypothetical investors, Polly and Sam. Both start with $100,000. Prudent Polly is a value investor. She spends her time researching a handful of industries she understands well. After months of work, she builds a portfolio of 15 stocks, investing between 5% and 8% of her capital in each. She can explain every single business model and has a clear thesis for why each stock is undervalued. Scattered Sam is worried about risk. He reads headlines, listens to TV pundits, and gets tips from friends. He ends up buying small amounts of 120 different stocks. His largest position is 1.5% of his portfolio. He can't name half the companies he owns, let alone explain what they do. He believes he is “safer” than Polly because he is more diversified.
| Investor Profile | Prudent Polly | Scattered Sam |
|---|---|---|
| Strategy | Value-based concentration | “Safety in numbers” |
| Number of Holdings | 15 | 120 |
| Average Position Size | ~6.7% | ~0.8% |
| Level of Understanding | Deep knowledge of each company | Surface-level or zero knowledge |
| Portfolio's Top Holding | “Steady Brew Coffee Co.” (8% position) | “HotStock Tip Inc.” (1.5% position) |
The Outcome: Steady Brew Coffee Co., Polly's top holding, is a fantastic business that she bought at a great price. Over two years, it triples in value. This single stock adds 16% to her entire portfolio's return ($8,000 gain on a $100,000 portfolio). Her deep research paid off handsomely. By pure luck, one of Sam's 120 stocks also happens to be a huge winner and triples. Because it was only a 0.8% position, this spectacular success adds a mere 1.6% to his total portfolio return. The impact of his winning pick was almost completely diluted by the other 119 mediocre holdings. When the market experiences a 20% downturn, Polly reviews her 15 companies. She knows they are financially strong and their long-term prospects are unchanged, so she holds steady, confident in her analysis. Sam panics. He looks at his 120 holdings, has no idea which are strong or weak, and sells many of them near the bottom, locking in his losses. Polly's concentrated, knowledge-based approach led to superior returns and rational behavior. Sam's over-diversified, ignorance-based approach led to mediocre returns and emotional mistakes.
While value investors view over-diversification as a significant flaw, it's important to understand the psychological reasons it's so common.