If you place all your stock investments in an S&P 500 index fund, have you diversified your investments?
In my opinion, not really.
What often scares many investors out of stocks are the sudden drops. As much as people nod in agreement that you cannot enjoy the long-term ups without enduring the temporary drops, they often bail when the going gets tough.
And, let’s face it, we all have a breaking point.
One of the basic ideas of stock diversification is to own investments you believe will go up in the long run, just not all at the same time. That would reduce the fluctuations of the overall portfolio without necessarily reducing overall returns.
I think there’s a good potential for fewer ups and downs by considering a portfolio to include other stock indexes, like U.S. small companies (unlike the S&P 500, which covers very large U.S. companies), developed world companies, emerging markets companies to name a few.
Over the past 15 years, according to research by Wells Fargo Investment Institute, the S&P 500 returned 8.8% annually, while the developed world, excluding the United States, returned only 2.3% annually.
If you invested $100,000 in each of these investments at the start of 2008, the S&P 500 investment would’ve grown to more than $350,000, while the developed world investment came in at $140,000.
That should catch the attention of anyone who believes investments return to their mean.
For the 15-year period starting seven years earlier, the annual returns for the same two indexes were 5.0% and 4.0%, respectively.
That’s a quick reminder that just because one investment has done great for 15 years, it won’t automatically continue to do so for the next five, 10, or 15 years. Investing isn’t that easy.
Who’s to say we’re not on the verge of another reversal over the next five or more years?
Since none of us knows the answer, I think we’re better off sticking to a discipline that includes reasonably available alternatives that fit your objectives.