Does Diversification Really Work?
Updated: Jul 14, 2019
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I gave a corporate seminar this week and one of the participants asked if diversification really works. She had referred to a pie chart she had seen 15 years ago and thought that it was not relevant any more due to market for the last few years. While I understand her lack of faith in the markets, I showed her the actual numbers for the last 10 years. By being properly diversified, you are able to prevent too much loss in your retirement portfolio and still capture the upside of the market when it does well. There are two ways to look at it:
o Proving diversification really works by showing the actual numbers for the last 10 years.
o Giving tips on how you can actually implement.
What is diversification? The textbook answer is spreading your risk among different types of investments. My real life answer is making sure you have a consistent percentage between stocks and bonds. Then take it a step further – you have to REBALANCE YOUR PORTFOLIO EVERY YEAR!
Let’s first show you the numbers. In the last 10 years, the S&P 500 was negative in 2008, 2002 and 2001. A diversified portfolio* (35% bonds, 65% stocks) went down much less. For example:
o 2008 the S&P 500 was down -38%. Our diversified portfolio was only down -23%.
o 2001 (after the dot com bubble burst) the S&P 500 was down -12%. Our diversified portfolio was only down -3%.
How do you implement it?
o If you are investing in a 401k, that’s easy. Just do a checkup on your 401k portfolios every year and make sure your percentages are still within the numbers you decided at the beginning of the year. If not, adjust your percentages accordingly.
o If you manage your own retirement money through IRAs, you are either adding money every month or every year. You first need to check which part of your portfolio is underallocated. Then add the extra money to that portion.
Not sure how to implement this yourself? Sign up for "4 WEEKS TO YOUR STRONG FINANCIAL FOUNDATION" or call us for a diversification checkup!
* This diversified portfolio is made up of Vanguard Index funds: 35% Large Cap, 15% Small Cap, 15% International and 35% Bonds.