Why Diversification Matters in 401k Management
“In the world of investing nothing is as dependable as cycles” – Howard Marks, Oaktree Capital chairman
We want to illustrate the randomness of markets and why diversifying is a good idea.
We put together the following chart to do just that. It shows the performance of several of the major asset classes over the last 10 calendar years updated through 12/31/2016.
A Few Things About Diversification Jump Out
While US markets have rebounded strongly since the global financial crisis in 2007-2008, international markets have lagged for the most part. Unfortunately, this is causing a lot of investors to abandon their international funds or avoid them altogether. If we extended this chart back a few years further, the opposite would have been true. Another reminder that markets are cyclical. Nothing new to see here.
Poor commodities. They had their first positive year of the past six years in 2016. Even after that gain, the asset class is down around 50% since the beginning of 2011. Commodities still have a place in a diversified portfolio, but if you have been banking on the return of the gold standard, you have likely been disappointed.
Looking only at this chart, bonds seem to be a dependable source of a decent return. However, like all history, context is everything. We’ve seen a 30-plus year bull market in bonds where the 10-year treasury yield went from over 15% in the early 1980’s to around 2.5% at the end of 2016. Falling interest rates are a positive for bond prices, but they can only fall so far. The next decade will likely look different for bonds.
The Diversification Chart Teaches Valuable Investing Lessons
First, there will be up years and down years. Chasing the best performing asset class of the previous year won’t yield great results. Oftentimes, the top performing asset class one year will be near the bottom of the pack the next year, and vice versa. Other times, an asset class’ relative performance will persist (see: commodities from 2011-2015 or US large cap from 2013-2016). The point is, the future is unknowable.
If you’re relying on your (or anyone else’s) ability to time the market, you’re doing it wrong.
Second, you must accept some risk (volatility) to get a return over the long haul. Cash won’t get you there. For investors with a shorter time horizon until retirement, holding a portion of your portfolio in cash is a great way to meet short-term spending needs, but it’s a terrible way to build long-term wealth as the almost non-existent returns on cash over the past decade have shown.
Knowing that you have to accept risk to build long-term wealth, and that you don’t know which asset classes are going to provide the best long-term return, diversifying seems like a no-brainer. The old adage is “don’t put all your eggs in one basket.”
It’s easy to see why. The markets ebb and flow with little rhyme or reason. Don’t risk your future by betting everything on one horse.
If The Above Diversification Chart Just Makes You Cringe
You’re not alone. You’ve done the hard part – you’ve started saving. We’re here to help you do the rest. Here’s what to expect if you become a blooom client:
The information above is provided for discussion purposes only and should not be considered as investment advice. We do not guarantee future results, and a diversified managed portfolio is not a guarantee against loss.