The Case For Diversification

Since my very first day in the wealth management business, I was exposed to the power of a diversified portfolio that covers all the boxes in the Ibbotson periodic table. For the 1^st 10 years, this could not be argued. The market went through drastic swings to the downside like the Tech bubble of 2000 or Financial Crisis of 2007. Most diversified portfolios did have favorable performance to the S&P 500, but still negative. The rule of thumb in investing did its job.

As I look back over the last decade, the results don’t seem as successful. This can be attributed to many factors, most importantly the risky investor became “not so risky” after the Great Recession of 2007. This could be interpreted that the investor was not risky at all, but the power of wealth can sometimes skew the emotions that come with investing in stocks and assessing one’s risk appetite.

I recently had the pleasure to meet with a Representative with Blackrock Funds and ETF’s. Blackrock has always been a firm that I paid great attention to. After all, they started as a risk assessment firm before they became one of the largest investment management companies in the world. I expressed my frustration with giving the suitable advice to clients and getting burned by underperformance of the portfolio to the S&P 500. Even though a majority of the assets held for the client were not in the S&P 500. A typical Growth and Income portfolio made up of 40% bonds, 60% stocks of all capitalizations and global presence, was being compared to the S&P 500 index.

Figure 1

The representative had a great slide that was put together by Blackrock (figure 1). It is a simple chart that tracks the S&P 500 and a diversified portfolio of 60% S&P 500 / 40% U.S. Aggregate bond. This comparison is easy to see that the returns are much different in each column. This comes as no surprise, because the risk is not the same. The diversified portfolio only has 60% exposure to equity markets.

The most important visual for me was the client thoughts on the right. In the years 2000-2002, the client was not happy being down -13.3% “I LOST MONEY”. Albeit not as much as the S&P500 -37.6%. The same is true for 2008 and 2018. Conversely, when the portfolio was up in the years 2009-2017 (+152.1%), but lagged the S&P (+258.8%), the client was not happy because they didn’t make as much. This was not a drastic as 2003-2007, but still has the same characteristics. This has been my experience through my 20+ years in the industry.

We always tell our client invest for the future, with a long term time horizon. Trust your allocation and risk assessment. These thoughts ring true at the bottom of this slide “Total Return”. The growth of $100,000 from 2000-2018 is $246,570 (S&P 500) and $266,110 (diversified portfolio). Even though the diversity did not perform as well in the big up years, the client still won in the long run!!! Yes, not by a lot of actual dollars, but remember you are only taking 60% of the risk of the market.

Jason Jennings, CFP®

Managing Partner

 

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations. Any economic forecasts set forth may not develop as predicted.

 The Institute for Supply Management (ISM) index is based on surveys of more than 300 manufacturing firms by the Institute for Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders, and supplier deliveries. A composite diffusion index is created that monitors conditions in national manufacturing based on the data from these surveys.

Purchasing Managers’ Indexes (PMI) are economic indicators derived from monthly surveys of private sector companies, and are intended to show the economic health of the manufacturing sector. A PMI of more than 50 indicates expansion in the manufacturing sector, a reading below 50 indicates contraction, and a reading of 50 indicates no change. The two principal producers of PMIs are Markit Group, which conducts PMIs for over 30 countries worldwide, and the Institute for Supply Management (ISM), which conducts PMIs for the U.S.

Because of its narrow focus, specialty sector investing, such as healthcare, financials, or energy, will be subject to greater volatility than investing more broadly across many sectors and companies.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) maybe appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

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.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.