Diversification is one of the defining principles of long-term investing success. It is simply a strategy that mixes a variety of investments and can be considered part of a risk management strategy.This technique’s rationale is that a collection of different assets will, on average, potentially yield higher long-term returns over time and lower risk versus any individual security. Another way to say this is not having all your eggs in one basket!
At Kletschke Wealth Management Group, we review a client’s mix of asset types, company sizes, credit quality, geographic location of its revenues, industries, among other criteria. This balance seeks to help investors remain committed to a long-term investment strategy, despite the inevitable ebb and flow of performance, while potentially minimizing the risk of overconcentration or performance chasing. When the diversification is overweighted by a high-performing group of companies, rebalancing may minimize this risk. You can consider it as a regular process designed to buy low and sell high with the goal of keeping your risk in check.
Although history has clearly demonstrated the benefits of diversification, it has also been a source of frustration over the last few years. Returns of market cap-weighted benchmarks have masked the wide performance disparities between asset classes, sectors, geographies, and styles.
Not All Stocks Have Been Equal
The performance of the cap-weighted S&P 500 index, representing 500 large, leading U.S. companies, can vary from that of its equal-weighted counterpart. Not all stocks in the S&P 500 are profitable. The returns have been disproportionate across economic sectors. This helps to illustrate that a few large companies in the same sectors can swing the performance of the broader group. As we learned in 2000, that can present challenges when portfolios are not rebalanced periodically.
David Versus Goliath
Size does make a difference during different economic cycles. For example, during the COVID- 19 pandemic, large companies widened their performance gap over smaller companies. The size and scale of larger companies gave them an advantage over smaller companies that experienced great disruptions. As the economy reopened, some small and mid-sized companies delivered impressive returns. Diversification across cap sizes may be helpful in lowering portfolio risk.
Looking for Value
One of the most persistent trends over the “growth” decade has been the outperformance of growth versus value stocks. Following such extreme performance disparities, value stocks tend to outperform growth stocks over an extended period. We saw similar trends in the late 1990s when it was difficult to convince clients to have value stocks in their portfolios. When the ‘Tech Bubble’ hit in 2000, investors who were poorly diversified experienced significant declines in their asset values. Deploying a rebalancing strategy over the years tends to reduce the risk. Now that we have seen great performance over the “growth decade,” it may be time to rebalance and consider value-oriented investments as part of your strategy.
Frustration or Opportunity?
Over time, there have been cycles in certain areas of the market that have had many investors questioning the benefits of diversification. We saw that in the late 1990s as well, and look how things turned out for those who solely owned technology companies in 2000. We believe that this crossroad is here again with growth versus value stocks. Investors willing to look beyond past performance of value stocks will see the opportunities in the months and years ahead. Change will happen. It always does. Perhaps it already is.
If it has been awhile since your last portfolio review of your diversification, please contact Kim, Korey, or Tyler at Kletschke Wealth Management Group, and let’s talk about how we can help you.
Article prepared by Stifel affiliate EquityCompass Investment Management, LLC.
Stifel does not offer legal or tax advice. You should consult with your legal and tax advisors regarding your particular situation. Diversification does not ensure a profit or protect against loss. Investing involves risk, including the possible loss of principal. Past performance is not an indication of future results. Rebalancing may have tax consequences, which you should discuss with your tax advisor.