What's the most cost-effective campaign structure?

2 options:

1. The keywords in an ad group share 1 term- e.g blue widget, red widget, yellow widget

2.The keywords in an ad group share 2 terms-
red widget online, red widget buy, red widget great etc.

I understand that option 2 is better, but will I get Penalized (in terms of min cpc, exposure, quality score) for choosing option 1?

If I choose to build my ad groups as in option 2 it would mean breaking down the keyword list into very small and targeted ad groups, which is very time consuming.

I prefer to start with option 1, and break down the ad groups (or "pill and stick") only when I see some traffic that justifies the work. On the other hand if I get penalized (even unknowingly by getting less exposure) I'll go for option 2 from the beginning.

Would love to hear your opinions about this approach.

As you could imagine, the more targeted, the better. Two reasons: #1 Because words in your ad which are included in the user's search are in bold, so it draws a lot more attention to your ad. The CTR will also be astronomically higher when the ad is specifically what the user is searching for. #2 Because the more targeted the landing page, the higher the conversion rate, because the user doesn't have to (and most likely won't) go searching through your site to find what it is they are looking for. They'll just hit the back button in the browser and return to the search results and move onto the next listing.