Contributed by: Jaclyn Jackson
As investors, we’ve always been taught that portfolio diversification is essentially for good portfolio performance. Yet, we’ve experienced three consecutive years that have some of us second guessing that old adage. Case and point, evaluating the broad bull market from March 2009-December 2012 and the mostly flat market from December 2012–September 2015, it is clear that sometimes diversified asset classes perform well and at other times they do not. During the period of March 2009 through November 2012, diversification generally helped returns. From December 2012 until August 2015 diversification away from any “core” asset classes generally hurt returns.
Source: PIMCO
Source: PIMCO
Core asset classes (top) reflect the overall positive direction of the most common markets during both periods. Comparatively, diversified asset classes (bottom) generally helped portfolio returns from 2009-2012 as indicated by the blue lines showing positive returns, but thereafter generally detracted from returns as indicated by the red bars with low to negative performance. Based on this data, it’s easy to consider using a core-only investment strategy without the frills (or frustrations) of diverse investments. However, there is one key point that we can draw from the diversified asset graph; unlike core assets, diversified assets don’t move in tandem with the market. Believe it or not, that’s actually what’s great about them.
Many people think diversification is meant to improve returns, but it would be useful to reframe that idea; diversification is meant to improve returns for the level of risks taken. In other words, diversified investments work to balance core investments during down or volatile markets. Let’s look back at the market bottom of 2009.
The graph illustrates that a non-diversified (stock-only) portfolio lost almost double the amount of a diversified portfolio. Moreover, the diversified portfolio bounced back to its pre-crisis value more than a year before the stock-only portfolio. This type of resilience is especially important for retired investors that rely on income from their portfolios.
Not only is portfolio diversification useful for people who’ve met investment goals, it is equally helpful to long-term investors. For investors still working toward financial goals, portfolio diversification can help produce more consistent returns, thereby increasing the prospects of reaching those goals. The diagram below ranks the best (higher) to worst (lower) performance of 10 asset classes from 1995-2014. The black squares represent a diversified portfolio.
Source: SPAR, FactSet Research Systems Inc.
The black squares generally middle the diagram. As evident, the range of returns for a diversified portfolio was more consistent than individual asset classes. Returns with less variability are more reliable for setting long-term investment goals.
Admittedly, portfolio diversification over the last three years has made it difficult for many to stick with their investment strategy. Yet, portfolio diversification still holds merit: it can help mitigate portfolio risk; it can boost portfolio resilience; and it can provide investors the consistency necessary to set and meet financial goals.
Jaclyn Jackson is a Research Associate at Center for Financial Planning, Inc.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Jaclyn Jackson and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Diversification and asset allocation do not ensure a profit or protect against a loss. Investing involves risk and investors may incur a profit or a loss regardless of strategy selected. Past performance is not a guarantee of future results. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary.
The historical performance of each index cited is provided to illustrate market trends; it does not represent the performance of a particular MFS® investment product. It is not possible to invest directly in an index. Index performance does not take into account fees and expenses. Past performance is no guarantee of future results. The investments you choose should correspond to your financial needs, goals, and risk tolerance. For assistance in determining your financial situation, consult an investment professional. For more information on any MFS product, including performance, please visit mfs.com. Investing in foreign and/or emerging market securities involves interest rate, currency exchange rate, economic, and political risks. These risks are magnified in emerging or developing markets as compared with domestic markets. Investing in small and/or mid-sized companies involves more risk than that customarily associated with investing in more-established companies. Bonds, if held to maturity, provide a fixed rate of return and a fixed principal value. Bond funds will fluctuate and, when redeemed, may be worth more or less than their original cost. Note that the diversified portfolio’s assets were rebalanced at the end of every quarter. Diversification does not guarantee a profit or protect against a loss. to maintain the equal allocations throughout the period. Standard deviation reflects a portfolio’s total return volatility, which is based on a minimum of 36 monthly returns. The larger the portfolio’s standard deviation, the greater the portfolio’s volatility. Investments in debt instruments may decline in value as the result of declines in the credit quality of the issuer, borrower, counterparty, or other entity responsible for payment, underlying collateral, or changes in economic, political, issuer-specific, or other conditions. Certain types of debt instruments can be more sensitive to these factors and therefore more volatile. In addition, debt instruments entail interest rate risk (as interest rates rise, prices usually fall), therefore the Fund’s share price may decline during rising rate environments as the underlying debt instruments in the portfolio adjust to the rise in rates. Funds that consist of debt instruments with longer durations are generally more sensitive to a rise in interest rates than those with shorter durations. At times, and particularly during periods of market turmoil, all or a large portion of segments of the market may not have an active trading market. As a result, it may be difficult to value these investments and it may not be possible to sell a particular investment or type of investment at any particular time or at an acceptable price. https://www.mfs.com/wps/FileServerServlet?articleId=templatedata/internet/file/data/sales_tools/mfsvp_20yrsb_fly&servletCommand=default