Why Under-diversification Could Be Disastrous Right Now

Valuations in some growth sectors such as technology are currently approaching obscene levels. We’ve seen some selling in certain names in recent days, however, the outperformance in the technology sector has been compelling. Investors looking for return have been corralled into such sectors, unwilling to underperform the markets.

I think this mentality can be quite dangerous. It’s okay to underperform the broader stock market, particularly when the vast majority of returns come from a few companies. I think right now the risk level of certain growth sectors has increased to a level that makes the risk-reward of these stocks untenable right now.

Additionally, I think there’s a very real possibility we see a rotation away from these growth stocks into value plays in the coming quarters. There’s a point at which every stock or sector can become overvalued, and I think we’re approaching that level.
In order to combat too much concentration in one specific sector, I’d encourage investors to have a fully diversified portfolio. Doing so will smooth out returns in down markets. Additionally, if we see valuations revert toward normalized long-term historical levels, I think overbought sectors like technology could correct to a much greater degree than others.

Being fully diversified takes a lot of this risk off the table. Unfortunately, this might mean slightly lower returns right now. However, investors looking to manage their personal finances ought to keep capital preservation as the number-one goal – returns second.

Invest wisely, my friends.