Financial FitnessGeneral Information

The Case for Diversification

By January 31, 2019 No Comments

What does it mean to diversify?

I think an important concept that we’ve all heard over the years, but I think is often underutilized, is the case for diversification. When I was growing up, one of the concepts that my Dad shared with me as an investor was not to put all of your eggs in one basket. Of course, at 16, I didn’t have a lot of money to diversify so it didn’t really sink in until later in life.

This is a chart that MFS has put together showing a total of 10 different asset classes and their performance over the past 20 years., where they go back 20 years.

They put the best performer for that year at the top, and the worst performer at the bottom. For example, in 1998, the best performing asset class was large cap growth, and it was also the best performer in 1999. And then in 2000, 2001, and 2002, large cap growth was towards the bottom, and then in 2003 it was in the middle, and then it slipped in 2004, and then it started to gradually go up in 2005 and 2006, and 2007 it was the second-best performer, 2008 it was towards the bottom. 2009 it was at the top.  If you look at the far-right column, you’ll see that on average return over the last 20 years for large cap growth stocks through the end of 2017 has averaged 6.87%.

Why does diversification matter?

What’s interesting is if we took an equal percentage and put 10% into each one of these asset classes, you can see with the black square — they’ve defined that as a diversified portfolio.  As you can see, the diversified portfolio tends to stay in the middle. But most importantly, look at the far-right column. The difference between the large cap growth over that 20 years at 6.87% return and the diversified portfolio of 6.72% is very little difference with significantly less volatility.

So this chart illustrates the importance of diversification, not only in terms of overall performance. But more importantly, in terms of not having so many peaks and valleys in your portfolio.

 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.  All performance referenced is historical and is no guarantee of future results. 

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.