Ah yes, the “D” word. Most investors are familiar with diversification and its importance. However, what is good for us, isn’t always easy (see: going to the gym, skipping that donut etc.)
In recent years diversification has hurt investment returns. For example, from the market low in March of 2020 through the end of 2021 the S&P 500 index rose 119%. During such times of robust growth in the S&P 500, it’s unlikely a diversified portfolio can deliver such returns. In the data provided below, a diversified portfolio returned just 66% during the same period (almost half the return). In markets like these, it’s easy to question why we diversify at all.
The answer to that question requires perspective (and time horizon). The graphic below is an excellent reminder that while diversification is often (very) uncomfortable, it may help us reach our financial goals.
The example below shows that in periods of negative S&P 500 returns, the diversified portfolio still loses money! But not as much. It shows that in periods of positive S&P 500 returns, the diversified portfolio usually doesn’t gain as much! But it still made money. Interestingly, over the 20+ year time horizon, the total return of the diversified portfolio was the same as the S&P 500, with much lower volatility.
Volatility. Another word most investors are familiar with – and a concept closely tied to diversification. For most investors, the volatility of the market can be extremely difficult to deal with. Investing in the stock market often means highs which are very high, and lows which are very low. These wild swings are enough to cause emotional decision making when it comes to our money. Diversification is as much about helping us make good decisions as it is about investment returns.
By diversifying we attempt to decrease the volatility of a portfolio. This can make it easier to make smart investment decisions and stay the course with a financial plan. At TVAMP, we believe the best strategies are often the most simple ones – but simple isn’t always easy.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. This information should only be relied upon when coordinated with individual professional advice.