I recently had the pleasure of spending the weekend with my wife and daughter at Disney’s Epcot theme park. Coincidentally, it was the same weekend that Disney premiered its new affiliation with George Lucas and the Star Wars franchise. The parks were overrun with Star Wars fans, and being a child of the ‘70s, I was a little struck with nostalgia too.
With the addition of Star Wars to their stable, I was reminded of how diversified Disney is as a business and how we subscribe to the principle of diversification with our client portfolios. Diversification offers many benefits, but sometimes we have to be reminded that diversification does not mean all investments held within a portfolio are always headed in the same direction. In fact, if they were, the portfolio wouldn’t be diversified!
To illustrate what I mean, let’s take a look at the chart above. It shows the difference in returns between the best- and worst-returning asset class per year. You can see that the difference between returns has been quite large at times, the greatest difference coming in 2009 when Emerging Market stocks beat 5-year US Treasuries by 80.9 percentage points.
Over the past 40-plus years, the average difference in returns between the top and bottom asset class has been about 50%. That means a diversified portfolio held some assets, which at times, appeared to be real losers. It’s impossible to know which asset will do well and which ones won’t, because returns are random and unpredictable from year to year. The uncertainty of yearly asset class fluctuations is the price we pay for long-term growth.
When you have a truly diversified portfolio, some of the holdings will be losers. But don’t let the performance tail wag the investing dog — today’s losers often become tomorrow’s winners. Remember International stocks were last year’s losers and today they are leading the pack. Successful investing is goal focused and planning driven, not market focused or performance driven. Remember this and your odds of success will improve.
Just a reminder, diversification cannot ensure a profit or prevent a loss in a declining market.