The Diversification Blues

Typically, over the long-term, diversification provides investors with upside potential in addition to giving portfolios protection against sudden, large losses.  Over the short-term, some investors become impatient and wonder why they hold certain assets in their portfolio, especially when one asset class is significantly outperforming others.  This was certainly the case in the late 1990’s when domestic growth stocks were significantly outpacing domestic value stocks, international stocks and bonds.  In the early 2000’s investors who gave up on value stocks and bonds were given a strong reminder on why it is important to hold a diversified portfolio over the long run as domestic growth stocks were crushed and value stocks and bonds held up very well.

Today’s investment climate is eerily similar to the late 1990’s.  Domestic growth stocks have outperformed the other asset classes significantly and people are starting to question the merits of diversification.  Our advice is to not cancel your flood insurance right before hurricane season.

Through August 23^rd, US large cap growth stocks are up over 15%.  US large cap value stocks are up less than 3%.  The US Core Bond Index is down about 1% and the MSCI EAFE International Index, priced in dollars, is down over 3% (all performance numbers taken from Morningstar.com).  Many investors are surprised that a balanced portfolio comprising all the above asset classes is only up marginally so far this year and depending on the allocation to US value stocks, bonds and international stocks some portfolios are actually in the red.

Looking at investor cash flow trends, a lot of money is leaving US value stocks and international stocks and going into US large cap growth stocks.  This reminds us of what one of our mentors used to say during such times, “sell low, buy high, repeat until broke”.  As humans it feels good to get out of an underperforming asset class and add to investments that have done well recently, but this is not a good long-term strategy.  At some point the markets will revert to their long-term averages, value and international stocks will have their day and those investors who resisted the urge to load up on growth stocks and stay diversified will most likely be rewarded.

Staying balanced and diversified may not always feel good, but it is the best way we know of growing and retaining wealth over time.  As always, feel welcome to call or email us with any questions or concerns regarding your portfolio.

Enjoy the rest of your summer.

The Bond&Devick Team