The power of diversification

“Holding a diversified portfolio of asset classes and investments means you don’t have to try to pick and choose the best performing section each year (which is impossible to do anyways).” – Ben Carlson @awealthofcommonsense

This chart is one of my favourite ways of demonstrating the importance of diversification for those who are thinking about retirement or who have already hung up their spurs.

asset quilt 2019

Going back to the financial crisis in 2008, it shows the annual returns for 15 different asset groups, including stocks in different regions and with varying market capitalizations, both corporate and government bonds, cash, gold and real estate. For comparison, I have also added inflation figures to the mix.

If we dig into the data, some interesting themes emerge:

Just because an asset performed well in any given year, doesn’t mean that it will continue to do so. Since 2008, there were 15 instances where an asset in the top 3 performers one year was also in the bottom 3 either the following year or the preceding year.

Cash isn’t king. There have been a couple of years where stocks performed poorly and holding cash paid off. During the financial crisis and last year (2018) being good examples. This is why holding a couple of years’ worth of cash is so important if you are in retirement. It means that if markets do fall, then you don’t have to sell declining assets to fund your lifestyle.

However, over the medium to long term, the data shows that cash is a poor investment as it loses value relative to the rising cost of living.

No rhyme or reason. Over the 11 years in the chart, 9 different assets held the top performer slot. Also, there was only one occasion, 2012 and 2013, where the top performing asset was the same in consecutive years.

This is because different assets and investments have their own characteristics and perform better or worse in different economic environments.

The power of diversification is that you don’t have to try to pick and choose which sector will perform best in any given year. Done correctly, you should always own some assets that are performing reasonably well.

Further reading:

 

Do you feel that your pensions and investments are sufficiently diversified? Contact me if you would like to review them.