Is There Such A Thing As Too Diversified?

by: Pey Shadzi

I think it's safe to say most of us financial information junkies here on Seeking Alpha have fond memories of some kind from our younger years. Maybe you can sink your thoughts back to the time you met your first girlfriend, secured your driver's license or lined up for your first job interview. Man, those were great times.

Feel free to call me weird, but many of my fondest moments stemmed from sprinting home from school, backpack flailing in the air, calves burning, to watch one of my favorite childhood shows: MTV Cribs.

For those of you who were actually normal kids and didn't have the attention span of a three-year old, please let me explain. MTV Cribs was a show popularized in the 90s by the fact MTV (Music Television) would visit the houses of ridiculously famous people to see how big their house was, how many rooms it had, what unique and interesting things it contained and, most importantly, how much it cost. At the end of every segment, MTV would head out to the driveway to see the the many rare types of cars these famous musicians and actors would drive and viewers would often get to see mega celebrities, such as P. Diddy, explain interesting details about his line of foreign sports cars as far as the eye could see.

At the end of the show, I would always shake my head as I began flipping the channels to other shows often asking myself, "who in their right mind would need that many cars?"

Obviously, most people only need one, maybe two, cars in order to fulfill their needs of getting around. For some reason though these celebrities -- often times pop musicians who sometimes had various feuds with other musicians -- would have 10 or more cars! "What's the point of that?" I often wondered. "Seems like a waste of money." Then it dawned on me: some of these celebrities might be nervous driving the same car around all the time since it makes them recognizable. "Ahh, I get it..." I thought. "They need more cars in order to protect themselves from others who might be jealous of their wealth." Deep thoughts from a 14-year old, I know.

Fast forward 15 years and I'm now in my 20s buying stocks. Interestingly enough, it's also dawned on me that owning one or two stocks, much like a celebritity worried about having only one or two cars, does not fully protect us from the negative potential outcomes of concentrating our wealth in too few investment vehicles. Though you've heard it before and you'll hear it again, diversification is an important step in any investor's wealth-mangement process in order to save us from dangers of concentration.

I recently wrote an article on Seeking Alpha, "Why I Choose to Collect My Dividends As Cash," where I explored the idea of collecting dividends in companies such as Dover Corporation (NYSE:DOV), Visa Inc. (NYSE:V) and Church & Dwight (NYSE:CHD) in order to reinvest them in businesses which pay higher dividends, such as General Electric Company (NYSE:GE) and Waste Management, Inc. (NYSE:WM). I truly feel this is a good method of reinvestment for me because it will likely allow for the faster compounding of dividends and, subsequently, net worth. I rather like that idea.

However, after beginning to utilize this strategy, I've noticed it becomes difficult to solely contribute to my core holding of stocks and, being a value investor who looks for bargains, the number of holdings has crept up from 20 at the beginning of 2011 to about 25 in 2012. So I've continued to diversify, picking up companies nearing their 52-week lows while faithfully contributing to my portfolio stalwarts... but the question still remains, is this necessary? Is it a good thing? Is there such a thing as too diversified? I suppose this depends on who you ask.

The current optimist, Warren Buffett, held very few companies such as GEICO, The Walt Disney Company (NYSE:DIS) and The Washington Post Company (WPO) early on in his career in order to quickly build his net worth and secure additional capital to keep moving forward. This is probably not a great strategy for most of us since Warren is an exception to the rule. However, I think most would agree holding a basket of 20 to 50 stocks -- quality, long-term holdings like ExxonMobil (NYSE:XOM), Abbott Laboratories (NYSE:ABT) and Johnson & Johnson (NYSE:JNJ), is a safer move than dumping our hard-earned money into one hopeful stock holding.

In addition to adding to my holdings in GE and WM for the attractive yields, there are a number of other treasury-beating yields out there as well. Here are two that I feel are worth a second look.

Aflac (NYSE:AFL) . Aflac is a dividend aristocrat, which provides supplemental health and life insurance products including cancer, dental, accident and disability plans. AFL is sporting a forward P/E under 7 while dishing out a dividend over 3% and a payout ratio of only 30%. I believe AFL is trading at a great discount when compared with its historical valuation. I feel very comfortable with Aflac, as it's one of my largest holdings.

Microsoft Corporation (NASDAQ:MSFT). Trading at just nearly nine times next year's earnings with a dividend near 3% and a payout ratio of only 23% is the software giant Microsoft. Its financial outlook is incredibly strong for a company estimated to pull in $3.04 per share in 2012 with over four times more cash on hand than debt. Truthfully, I'd like to see the dividend hiked up a bit but with such a low payout ratio, I'm willing to wait as I feel MSFT will likely reward shareholders with generious raises in the future.

The question of how many stocks to hold in an account to remain diversified is certainly a controversial one. For one, many factors play into this discussion such as age, risk tolerance and overal short-term and long-term goals. In fact, I wouldn't be surprised if hundreds of books were not written on the subject already. However, unless you have the mental capacity and investing prowess of Warren Buffett, it's not a bad idea to choose a basket of stocks, rather than just a few, in order to safeguard yourself against the threat of portfolio concentration. Just as I was taught by the pop celebrities of the 90s that driving around in only one car could be dangerous to your health, so too is the idea that allowing a significant portion of your net worth to reside in too few investments is acceptable.

Disclosure: I am long ABT, GE, DOV, V, AFL, WM, CHD, JNJ, MSFT, XOM.