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CIO Insights: Diversification Is Not Dead

Market downturns bring out the diversification haters. Does the strategy deserve the criticism?
By Richard Weiss
10/25/2022
Assortment of herbs and spices.

Every time there’s a market downturn, we hear complaints about diversification. Whether it’s skepticism for the diversification strategy in general or for the proverbial “balanced” 60/40 portfolio (which is down roughly -20% this year, as of 9/30*), this is a standard criticism.

But the reality is that the -20% may not seem so bad when compared to almost any other risky multi-asset portfolios, or stocks in general (the S&P 500® Index was down almost -24%).* And if one includes a broader diversification into (let’s say) market neutral strategies, commodities and other alternatives, those negative returns would have been mitigated even further.

Diversification From a Relative Perspective

One also has to judge the efficacy of diversification from all perspectives, not just our own. This year, because of the strength of the dollar, most non-U.S. investments have not added value for U.S. investors. But from the perspective of virtually any other country or currency, diversification into the U.S. has been beneficial. So, I would argue that a well-diversified strategy has performed fairly well on a relative basis.

Over the long term, a well-diversified portfolio tends to outperform most other, more concentrated allocations on a risk/reward basis. The reality is that the traditional 60/40 balanced portfolio remains a very tough bogey to beat over a long timeframe.

Mind you, that does not mean that a diversified portfolio never loses money. Rather, this balanced approach is a prudent way to pursue a reasonable return for the risk taken.

Stick to a Diversified Plan During Volatility…

People may be feeling financial whiplash right now, or that there’s no place to hide. I recognize that, but I want to offer two alternatives that may provide some comfort.

First, if you’re invested in a retirement plan or have developed a financial plan, then that means you almost certainly have a well-diversified portfolio with long-term strategic allocation targets. Those targets exist for a reason—they’re informed by decades upon decades of financial market data and risk/reward relationships between asset classes.

And they provide a further advantage in that if you absolutely, positively have to do something, you can rebalance your portfolio back to those long-term targets. Rebalancing forces you to sell winning assets and buy laggards, which is vastly preferable to panic selling.

Second, I’d ask you to recall that old saying, “it’s always darkest before the dawn.” That concept applies to investing as well. Some of the strongest rallies in equity markets start in the midst of a recession.

…And Don’t Try to Time the Market

Of course, we don’t advocate for trying to time market reversals. Jump into stocks with both feet and you risk “catching a falling knife.” Or, you need to identify when the economy is close to its worst, and we don’t think we’re there yet.

We really can’t see through to the bottom of this cycle yet. For this and other reasons, we just don’t advocate making wholesale moves in and out of asset classes—we believe market timing is a financially dangerous proposition. And that’s another reason why we argue for a long-term, diversified approach.

Author
Richard Weiss
Richard Weiss

Chief Investment Officer

Multi-Asset Strategies

Are You Diversified?

Talk to a financial consultant about how diversification can be a vital strategy during volatile markets.

The return for a 60/40 mix of the S&P 500 Index and the Bloomberg U.S. Aggregate Bond Index was -20.10% from 1/1/2022 to 9/30/2022. The return for the S&P 500 Index was -23.87% for the same period.

The balanced portfolio example is a combination of the S&P 500® Index, which represents 60% of the example, and the Bloomberg U.S. Aggregate Bond Index, which represents 40%. The S&P 500® Index is a market value-weighted index of the stocks of 500 publicly traded U.S. companies. Created by Standard & Poor's, it is considered to be a broad measure of U.S. stock market performance. The Bloomberg U.S. Aggregate Bond Index represents securities that are taxable, registered with the Securities and Exchange Commission, and U.S. dollar-denominated. The index covers the U.S. investment-grade fixed-rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities.

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.

Rebalancing allows you to keep your asset allocation in line with your goals. It does not guarantee investment returns and does not eliminate risk.

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

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.

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