Don’t Give Up on Diversification

January 7, 2016

2015 was not a good year for investors, especially for those in prudently-diversified portfolios.   Analysts have remarked that 2015 was the worst investment year for diversification in the last 70. 

The premise of such a strategy (such as the classic 60/40 ratio of stocks and fixed income/cash) is there may be years when one or a few asset classes will be provide the best return and other investments will be average or at the bottom.    The following year or years, the best ones may be the worst or average and the lagging ones of previous year(s) may now be the best.  The idea is there should be part of the portfolio that does well each year, even if another part does not.  This way, your investment planning remains on track toward your objectives and doesn’t overly suffer in any one year, since losses are harder to recoup.

That didn’t really happen in 2015.  Except for a few technology stocks, the equity markets disappointed investors across the board.  This included US stocks; large, mid-sized, and small as well as international holdings.  Bond investors did not fare well either, as the bond market was continually anxious over rising interest rates.  Late in the year, when the Federal Reserve decided to finally raise rates a quarter-point, the high-yield bond market went into a swoon.  So the “fixed income” portion of a diversified portfolio did not help much.

Neither did many so-called “alternative” investments.  Real estate-related investments may have been somewhat positive for the year, but commodities and energy were abysmal – so much so that they may have dragged down an entire portfolio into the red.

Since 2014 was not a great year either (unless you were heavily invested in large US stocks and if so, why?) many investors may be second-guessing themselves (or their advisors) and questioning their diversification strategy.  After a couple of disappointing years, investors are prone to the siren-song of supposed “can’t miss” offerings and those that promise all things good and no downside; something I warned about in a previous column (see Money’s Worth, Nov 28th  2015, Is it Too Good to be True?).

The truth about diversification, and investing in general, is there are bound to be years when this strategy (or any strategy) doesn’t work as well as expected.  The performance of the US market has paused over the last couple of years after the long uptrend from 2009 – 2013, so it’s not much of a surprise to have a disappointing year or few.  This is part and parcel of the investing process.  Down or flat years are never pleasant, but having these does not mean one gives up on a tried and true investing discipline, especially for the long haul.  It may help maintaining your patience to recall other periods of flat to disappointing years; most recently the rough years of 2000-2002 and the longer flat period of 1965 – 1981 (where the Dow Jones Industrial Average (DJIA) from 874 to about 875 over 17 yearsCompared to those years, investors today might feel grateful for just a couple years of flat returns.  Stay disciplined, stay diversified, and continue to save towards your long-term financial goals.