When it comes to portfolio construction, as well as portfolio allocation, one of the biggest areas that investors do not understand is the concept of dissimilar price movement. A simple example would be the idea of owning umbrella companies and sun tan lotion companies. Umbrella companies, unto themselves may be volatile, and sun lotion companies, they to would also be fairly volatile. However, when you add them together you see the value and the reality of what diversification or dissimilar price movement brings to a well-designed portfolio.
There’s no questioning in the arena of investments and financial planning that the use of “Modern Portfolio Theory”, which was fathered by Harry Markowitz, is scientifically sound and predominately practiced in finance. What we find when analyzing portfolios is a reasonable amount of different holdings, but a lot of stuff does not equal true diversification. The unintended consequences of an investors’ attempt to diversify, is most often just a lot of redundancy of the same companies held in different areas of their portfolio. Example: Is it good to own Apple in 10 separate funds? The result is a diminished market return because of the lack of true diversification.
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