Every now and then I hear the comment that index funds result in over diversification. The thinking goes that instead of buying all of the companies in an index, you might be able to focus on a smaller subset that you believe will perform better than the market.
It makes sense. Of course you can’t beat the market by holding it. The problem is that decreasing diversification leads to a wider range of possible outcomes, with a disproportionately large probability of a negative outcome, relative to the market.
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