Some evidence in favor of diversification
Capitalizing on Rahm Emanuel’s advice to “never let a crisis go to waste”, I continue to hear many investors talk about diversification is no longer a sound investing strategy. It is certainly tempting to think that way. After all, about the only way you would not have lost money investing last year is if you weren’t investing.
I have always been a fan of diversifying my investments. I come by my opinions by experience, by my educational training, and by plain old common sense. I am a strong believer that if you spread all of your eggs into different baskets, at least some of those baskets will remain upright and not scramble your eggs.
Two weeks ago, I found a great chart that validated my thinking. I am a regular listener to Brian Preston’s Money Guy podcasts. Preston does an absolutely fantastic job dissecting personal finance topics, and I highly recommend searching for his podcasts on iTunes. Preston provided a chart to his members showing how important diversification is. While I will respect Brian’s premium membership group and not share the graph, I will explain the concept. Fidelity created a chart that looked like the periodic table we remember from high school science class. Each investing class was color-coded, and returns from 1998 to 2009 year-to-date were charted.
If you saw the same classes always near the top or always near the bottom of the chart, then diversification would not make much sense. However, the chart looked like a Rubik’s Cube after mixing the cube. Colors were all over the chart, clearly showing that all asset classes have their good years and bad years. There were very, very few instances of an asset class remaining at the top or bottom of the table.
This chart reaffirmed my belief that diversification is important. If we invest in a single stock or single asset class, it is like betting on one number for a craps roll. I could never understand craps until I went to Las Vegas and my friend told me to always bet on the “come” bet. This was the bet where you could win in a number of different ways. Diversification works in the same way. Considering I won $160 at the craps table with my friend that night, I liked the diversification strategy at the craps table. Despite all of the turmoil we’ve seen in the market, I don’t think I’ll be moving away from diversification in my investments anytime soon.
