The Power of Portfolio Diversification
It's sometimes said that sound portfolio management is simple, but not easy. In other words, the concepts behind successful investment management are reasonably easy to grasp in theory, but are counterintuitive and emotionally difficult to implement consistently in practice.
Sticking with your stock market exposure in a disciplined fashion and focusing on the long-term is a lot more easily said than done when the financial world seems to be coming to an end as in 2008 and again earlier this year. And going the extra step to add to your equity exposure in that type of market environment, simply to bring your asset allocation back to its targets, is doubly difficult given that our brains are hardwired to scream at us to flee when faced with perceived danger.
Likewise, the concept of portfolio diversification is fairly easy to grasp but emotionally difficult to implement consistently. In bull markets for stocks, a diversified portfolio lags an all-stock one, so we feel like we're missing out. In bear markets for stocks, a diversified portfolio softens the blow, but losing less money is not very consoling. And in 2018, to make matters worse, many diversified portfolios actually fell more than the S&P 500, adding insult to injury. Yet, there is no doubt that over the long run, portfolio diversification improves risk-adjusted returns, in theory and in practice.
Sometimes a picture is worth a thousand words (and probably more of mine). So with credit to Blackrock, the mutual fund company behind the iShares family of ETF's that we use in client portfolios, here is a one-page graphic illustration of The Power of Portfolio Diversification. This illustration compares the actual returns of a diversified portfolio with those of an all-stock one in various market phases between 2000 and mid-2019.
We never feel very satisfied owning a diversified portfolio at the time, but in retrospect it is the best thing for us.
About the Author
Paul Winter, MBA, CFA, CFP® is a Fee-Only financial advisor and fiduciary in Salt Lake City, UT. His independent wealth management firm, Five Seasons Financial Planning, provides professional portfolio management and objective financial planning services to individuals and families, and to their related entities including trusts, estates, charitable organizations, and small businesses.