3D digital graphs superimposed over stock market screens.

The Surprising Truth about Diversification


Diversification is often touted as the most important strategy in an investor's toolkit. But if you read the fine print in your investment or financial education materials, you'd often see this line:

Diversification does not assure a profit nor does it protect against loss of principal.

If some of the investments in your diversified portfolio are gaining during a particular market environment and a few others aren't keeping up (or are losing value), everything might actually be going according to plan.

How can that be?

Let's dive further into what diversification is, and what it isn't.

Diversification 101

Diversification simply means spreading out your money over multiple asset classes (categories of investments) that respond differently to market changes. At a high level, those types of asset classes include stocks, bonds and cash positions. Each of those asset classes has its own characteristics: stocks and bonds may perform differently when the economy is booming or slowing down, when interest rates rise or fall or when political events make headlines.

Investing your money with different financial institutions or product types (stocks, mutual funds, exchange-traded funds, etc.) is NOT diversification. These variations won't help if your investments all act the same when markets move.

It Looks Like It's Diversified, but…

A portfolio can have a variety of underlying investments but still not be properly diversified.

Hypothetical Portfolios

Source: American Century Investments®. The hypothetical scenario is an example of what a diversified portfolio might look like.

Diversification should go beyond the general categories of stocks, bonds and cash. Each of these can be split further into more specialized categories:

Company Size
Large: McDonald's, Exxon Mobil
Medium: Mattel, Royal Caribbean
Small: Barnes & Noble, Etsy

Location
U.S.: Apple, Walmart
Non-U.S.: Nestle, Samsung

Style (stock-picking philosophy)
Growth: Stocks exhibiting growth potential
Value: "Bargain" stocks expected to increase in value

BUSINESS SECTOR
 Energy, health care, real estate, information technology, consumer staples, financials, etc.


Types
Treasury
Government agency
Securitized
Municipal
Corporate

Location
U.S. vs. non-U.S.
Developed vs. emerging markets

Credit Quality
Investment-grade
High-yield

Types
Money market investments
Certificates of deposit
Treasury bills

Not a comprehensive list of stock, bond or cash categories. References to specific securities are for illustrative purposes only and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.

 

Seek a Smoother Ride Overall

Some investments have more growth potential than others, so why not stick with all stocks, for instance? Because growth can go hand in hand with risk. For example, emerging markets stocks were among the top performers in 2017, gaining 37.75%; the very next year, they lost -14.57%. In 2019, emerging markets stocks were up 18.42%, but they weren’t even close to being the top performers for the year.1

Most investors aren't comfortable with such uncertainty, but research shows that no asset has a repeatable performance pattern. Owning different asset classes, however, can help prepare you for various market conditions and may help provide more consistent, less volatile returns over time.

Diversified portfolios have the potential to benefit from some the big gains (but not all) of their underlying assets and experience just some (and not all) of the big losses. The end goal is smoother pattern of performance and less anxiety for you.

One Option: All-in-One Diversification

Diversifying your investments may seem complicated if you try to research and select each type of asset on your own. Most mutual funds allow you to spread your money across securities in a specific category.

You can go beyond that with a fund-of-funds investment, which provides a mix of funds that cover multiple asset categories in a single product. More importantly, fund managers will carefully select and monitor the investments in these portfolios for their shareholders.


1Emerging markets stocks, as measured by the MSCI Emerging Markets Index. Source: American Century Investments Time-Tested Strategies for the Long Term .



Take the Next Step

Feel like you're not diversified or need help determining how to take a comprehensive view of your investments?

Diversification does not assure a profit nor does it protect against loss of principal.

Generally, as interest rates rise, the value of the securities held in the fund will decline. The opposite is true when interest rates decline.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

American Century Investments is not responsible for and does not endorse any comments, content, advertising, products, advice, opinions, recommendations or other materials on or available directly or via hyperlinks from Facebook, Twitter or any third-party website. Facebook, Twitter and LinkedIn are registered trademarks of their respective owners.