Diversification doesn’t cure all investing ills, but it can help create and protect your family’s wealth. While pundits tell us that taking on greater risk means higher returns, it doesn’t always work out that way. The following story may surprise you. Imagine two investors, each with $1 million. One invests aggressively—100% of assets into the stock market (S&P 500) and the other invests more conservatively—50/50% blend of stocks and bonds (S&P 500 and Barclays Aggregate Bond Index)1. Both investments are made at the peak of the technology/internet bull market—March 31, 2000. Results for each portfolio are shown below.
The chart tells the story of the old adage — “slow and steady” wins the race. While it’s exciting to participate in a “hot year” in the equity markets, for those concerned with steadily compounding their money and protecting capital, diversification is paramount.
During the past 15 years or so, the 100% stock portfolio (blue line) would have grown to about $1,900,000. That’s a $900,000 gain or 4.3% annualized return. The 50/50% stocks and bond portfolio (yellow line) would have had a steadier ride—dropping significantly less than the market during declines. But here’s the magic. That same $1 million would now be worth about $2,220,000. That’s a $1,220,000 gain or 5.4% annualized return over the same time period—significantly greater return with lower risk! Why? It’s based on the asymmetry of risk. In other words, as you go up the risk curve, returns only go up linearly while risk goes up geometrically—think of a curved line sloping up at an accelerating rate. More risk doesn’t always mean more return.
In the 2000-2002 market downturn, the stock portfolio dropped 47% (about $460,000) while the 50/50% stock and bond portfolio only dropped 18% (about $160,000). In the 2007-2009 market meltdown, the stock portfolio dropped 55% (about $670,000) while the 50/50% stock and bond portfolio dropped 29% (about $420,000).
Warren Buffett once famously said, “Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1.” The takeaway message—diversify.
--Brouwer & Janachowski, LLC
References to an individual security should not be construed as a recommendation to buy or sell that security. Please note indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.
While we gathered this information from sources we believe to be reliable, we cannot guarantee the accuracy or completeness of any statements or numerical data in this presentation. The information is subject to unintentional errors, omissions and changes without notice. By accessing and viewing this information, you acknowledge and understand the intended purpose of such information. Past performance is no guarantee of future results.