What it means
Diversification is normally praised, because spreading money or effort across different things lowers the damage when one of them fails. Diworsification is what happens when that sensible idea is pushed too far or done without thought.
The gains from spreading risk shrink, while the costs of running a bigger, messier collection keep growing. In investing, the classic case is an investor who owns dozens of overlapping funds.
Many of them hold the same big companies, so the portfolio looks varied but behaves like a single bet. Meanwhile the investor pays fees on every fund and finds it harder to track what is owned.
In business, it appears when a company buys unrelated firms simply because they are available or cheap. Management attention is limited, and a leadership team that understands furniture may struggle to run a software business or a chain of restaurants.
Results from the core operation can suffer as focus drifts away from it. The idea matters because it challenges the assumption that more is always safer.
Risk reduction from adding holdings has diminishing returns, meaning each extra item adds less benefit than the last. After a certain point the only thing that grows is cost, complexity and the chance of buying something poor just to fill a slot.
A useful test is whether each new addition has a clear job. A holding or business should earn its place by offering something the existing mix lacks, such as a different source of income or a different response to economic conditions.
If the honest answer is that it merely adds variety, it may be diworsification. None of this is an argument against spreading risk.
Investors and companies still need to avoid putting everything in one place. The point is to diversify deliberately, with a purpose and a limit, rather than collecting investments as if quantity alone provided safety.
In practice
Real-world examples.
Example
An investor holds 25 mutual funds, each charging about 1% a year. When she checks, she finds that most of them hold the same dozen large companies, so she pays 25 sets of fees for what is effectively one portfolio. She sells down to five clearly different funds and her costs drop sharply. She also notices that tracking so many statements takes hours each quarter, which she no longer has to spend.
Example
A regional bakery chain buys a coffee roaster, a catering business and a small online clothing shop in three years. The owners lack experience in the latter two, and profits from the original bakeries fall as attention shifts. They sell the clothing shop and the catering arm to refocus. The owners realise that the extra management layers they added to oversee these units have raised overheads for the whole group.
Example
A venture capital fund backs 60 start-ups in the first year, spreading its team across too many boards. Partners have little time to help any company, and the fund struggles to support its best prospects. The next fund concentrates on fewer, carefully chosen investments. Fewer holdings allow the partners to spend real time with each company and spot problems early.
Case study
Seen in the real world.
Brightwater Industries is a fictional manufacturer of garden tools that wanted to protect itself from seasonal sales swings. Over four years it acquired a swimming pool supplier, a pet food brand and a small chain of cafes.
None of the new units shared customers, suppliers or skills with the core garden business. In this illustrative case, head office spent most of its time resolving problems in the cafes, and the garden tools division lost market share to a focused competitor.
The board finally commissioned a review that showed the group earned lower returns than the tools business had done alone. It sold the cafes and the pet food brand, kept the pool supplier because it sold through the same retailers, and returned to a clearer strategy. The illustrative lesson is that diversification should be a decision with a reason, not a habit. The finance director now insists that every proposed acquisition is presented with a written answer to one question: what does this add that we do not already have?
Watch out
Common mistakes.
- Assuming that owning more investments always lowers risk. Beyond a certain point, extra holdings add cost and complexity without much extra protection. A few well-chosen, different holdings usually give most of the benefit at far lower cost.
- Counting funds rather than looking at what they contain. Ten funds that hold the same companies give almost no more diversification than one. Look at the top holdings in each fund and the sectors they cover, not just the fund names.
- Buying unrelated businesses just to smooth earnings. Without management skill in each area, the new ventures can destroy more value than they protect. Capital, time and expertise are all limited, and spreading them thinly weakens the core business.
Questions
People also ask.
Who coined the word?
It is widely credited to the fund manager Peter Lynch, who used it to warn investors and companies against collecting assets without a clear purpose. His book One Up on Wall Street helped spread the word and made it a popular joke among investors.
Is diworsification the opposite of diversification?
It is a warning about poor diversification, so it describes the point at which the strategy stops helping and starts hurting. The word is a play on diversification and worsening, which neatly captures the idea of a good idea going wrong.
How can I avoid it?
Give every new holding or business a clear job, check overlap with what you already own, and set a sensible limit on how many positions or ventures you will manage. A regular review of overlap, fees and purpose can catch the problem before it becomes expensive.
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