The term “diworsification” first appeared in the book One Up on Wall Street by Peter Lynch, in which he used the term to comment on companies that went into areas that were different from their core businesses, with disastrous results. Soon the word expanded into investment lingo, which described the situation where an investor diversified his/her portfolio to the point that it is not for the better, but for worse. As you may have guessed, diworsification is a word play of diversification, and it meant the dark side of the latter.
For Modern Portfolio Theory which The Bedokian Portfolio and I espoused on, diversification is one of the core tenets of investing, along with rebalancing. The main idea behind diversification is to spread out the investment risk amongst the holdings, so that a portfolio would not be hard hit should one, or a few, holdings collapse. Perhaps in the pursuit of diversification, some new investors may have practised it a little over-zealously, thus susceptible to diworsifying their portfolios.
Diversification, in my opinion, should be in the following order: asset class, regions/countries, sectors/industries and individual companies. To prevent diworsification from happening, it is best that a portfolio, at least in the beginning, should be made up of asset classes only, using exchange traded funds (ETFs). For a small portfolio sizing (four to mid-five figure sum), having just one or maximally two ETFs for an asset class is sufficient, for during rebalancing, it would be straightforward and lesser transaction costs incurred. Selection of the ETF is important and try to get those which give more exposure down the order at a lower expense ratio.
If your portfolio sizing had reached at least a mid-five figure level and if you are comfortable with the portfolio that you have, then just stick to it. You could try to diversify further down the order with specific ETFs (e.g., Asia Pacific ETF, banking sector ETF, etc.) or individual companies, but do consider whether the addition of counters and holdings positively complements your portfolio. If you want to add just for the sake of adding, then there is no point at all.
As long as one remembers why we diversify in the first place, and knows what one is doing, then it would be easy to avoid diworsification.