Diversification Can Make a Difference

Let’s look back for just a moment at where we were at the start of the year 2000, the end of the dot-com era. The markets were up substantially from where they were just a few years earlier, the NASDAQ was on fire, and there was talk in some circles of a new paradigm in investing, according to many so-called experts at the time. Remember that?

Markets were at or near record highs, and many people took the market trends as a sign that they should abandon diversification and focus strictly on U.S stocks in the Dow, S&P 500, or NASDAQ. So what happened? The ten years that followed gave us a -0.6% annualized return with dividends reinvested in the S&P 500. Many people have called this the “lost decade.”

Fast-forward to today. The ongoing bull market is by some measures the longest bull market on record since 1950. And even though we’ve hit some rough patches lately, there’s still talk in some circles about stocks going higher, which may have the effect of turning the focus away from diversification and into the 500 largest domestic stocks. Does this sound familiar? It should.

The truth is that nobody knows what the next ten years in the market will bring. We’ve seen a lot of volatility lately, and we’ll probably continue to see more of it going forward. But if you were a diversified buy-and-hold investor who reinvested your dividends back in 2000, you may not have experienced that lost decade in stocks. Over that same time period, the Russell 2000—an index of small-company stocks—generated a 6.3% return, U.S. real estate stocks earned 3.9%, and emerging market stocks generated a compounded return of 16.2%.

Diversification can make a difference. It’s not glamorous, but it could provide a great deal of protection on the downside. If you broadly diversify your equities by size, asset class, and geography and simply hold on, you may see better results over the long term.