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What is the price of diversification?

There are many aspects that create good portfolios and good returns.

Choosing the right industry is important. Choosing the right business is important. Buying at the right price is very important.

A key consideration that is often overlooked is how many shares do you want your portfolio to be exposed to?

Transaction costs

Every buy or sell that you make costs money, perhaps up to $20 or more. If you buy $1,000 of a business then it could cost 2% to enter the investment and another 2% of the original investment to exit it. It’s easy to see how investment costs can add up and hurt returns.

That’s why it’s important to focus on investing in long-term shares like Challenger Ltd (ASX: CGF) to give the business time to grow and you aren’t wasting money constantly trading in and out of shares.

‘Di-worsification’

Your favourite five or ten investment ideas will hopefully generate market-beating returns. But what about the next ten? Or the ten after that?

If your portfolio starts expanding beyond 40 holdings it’s important to consider if you’re worsening your investment performance just for the sake of diversification.

Of course, your investments could also include listed investment companies, real estate investment trusts, exchange traded funds and overseas shares that could expand your portfolio and be a benefit.

I think it’s important to know your reasons why you’re investing in a share, otherwise you should just keep it to winners like Altium Limited (ASX: ALU) and Ramsay Health Care Limited (ASX: RHC).

Management costs

Lots of investors prefer to get their diversification from investing in funds or investment companies, whether they’re active like MFF Capital Investments Ltd (ASX: MFF) or passive like Vanguard Australian Share ETF (ASX: VAS).

It’s important to be aware of the costs and the performance of your investment. If the management fee is 1% or higher then you want an investment team that consistently outperform the market over the long-term like MFF Capital does, otherwise you should focus on achieving the market’s return at the lowest cost.

Foolish takeaway

It’s a good idea to have diversification in your portfolio, a portfolio of just two or three shares would be a high-risk strategy.

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Motley Fool contributor Tristan Harrison owns shares of Altium, Challenger Limited, and Ramsay Health Care Limited. The Motley Fool Australia owns shares of Altium and Challenger Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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