Done right, diversification can improve portfolio returns while lowering risk. That’s why Harry Markowitz, creator of the Efficient Frontier, called diversification the only free lunch in investing.

Why is it then, in my portfolio reviews of prospective clients, that I often encounter a handful of stocks? Because investors tend to sell the “losers” and keep the “winners.”

Not being diversified is like sailing a yacht on starboard tack, sails full, crew leaning over the side to reduce heeling when suddenly the wind dies, and everyone’s scrambling to the other side.

And that’s not to say it’s always the captain’s fault. That’s life on the water. It happens.

The same is true for life in the markets. Look at the trashing in private credit. These junk-bond-like products were stuffed into portfolios sold with promising historical returns. Then, returns slowed, investors wanted their money back, and guess what? Withdrawals are being restricted to a small percentage of their original investment. What did investors expect would happen?

In my conversations with you, our discussions on diversification have as much to do with you as they do with what to buy. “In the past,” I ask, “how did you handle major setbacks in the markets? Were you forced to sell to sleep well at night, only to miss the boat during the recovery?”

This is not a dig. I understand: Being invested and staying invested is not for the faint of heart.

On the flip side, it’s crazy how many positions some professionals stuff into portfolios. Talk about going too far in the other direction. The overlap and rats’ nest of holdings is all over the place. There’s no real meaning behind the portfolio other than “let’s see what sticks.”

Action Line: Diversification done right can be more art than science. When you want to talk about diversification in your portfolio, email me at ejsmith@yoursurvivalguy.com.

Originally posted on Your Survival Guy.