Most advisors would agree that a portfolio, whatever the client’s age and risk tolerance, should be diversified and balanced, in terms of the proper allocation among stocks, bonds and other income-producing investments, as well as the equity choices.

But the question remains, how diversified and balanced should a portfolio be? After all, just as there are risks in diversifying too little or failing to rebalance, there are costs involved in diversifying too much or in rebalancing too often.

“I would worry about being too balanced,” said David Blanchett, head of retirement research at Morningstar Investment Managers in Chicago.

For example, “it would be silly to put a client into eight different balanced funds to try and cover more types of assets,” he said. “Trying to have too many asset classes can get costly.”

As Edwin Elton and Martin Gruber explained in their book Modern Portfolio Theory and Investment Analysis (Wiley, 2009), while increasing the number of stocks in a portfolio to 19 from one reduces risk to just 19.2% from 49.2%, adding a 20th stock doesn’t reduce risk at all. And increasing the number of stocks to 1,000 only reduces the portfolio’s risk by another 0.8%.

Meanwhile, Christine Benz, Morningstar’s director of personal finance, in an article on the research firm’s website, argued against rebalancing too often, which she warned would be a costly and time-consuming process for most individual portfolios, introducing transaction costs and potential tax liability.

Instead, she recommended rebalancing once a year for most portfolios.

Darrick Hutchens, a CFP and managing partner at Monon Wealth Management in Carmel, Indiana, agrees that advisors can overdo both diversification and balancing but for another reason.

“All the diversification and rebalancing we do won’t keep the client’s portfolio from losing during a downturn,” he said. “So, for us, the issue is more about figuring out how to build a portfolio of investments that our clients will hang with when the rest of the market is going up.”

Likewise, Hutchens said, it needs to be a portfolio of investments they will stay with when the rest of the market is going down.

“What we try to do is … a risk analysis and understand the client’s expectations, and then we arrange a portfolio not based upon academics but on what the client will stick with,” he said.

This story is part of a 30-30 series on building a better portfolio.

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