Investment
Diversification Shows Its Benefits
Some investors have experienced large losses in their portfolios during the past two years. Others have portfolios with nearly the same value as two years ago. The disappointed investors had concentrated portfolios, while the satisfied investors had diversified ones.
Extreme examples of concentrated portfolios included a single stock. Investors who held only Enron stock have lost essentially 100% of their money.
Less extreme, but very common, were portfolios that were similar to the NASDAQ 100 Trust and were held by investors who bought the technology stocks and stock funds that had incredible gains in 1999. Investors with concentrated portfolios in those stocks and funds lost about 57% during the two-year period of 2000 and 2001.
S&P 500 index funds became very popular in the late 1990's, because their performance exceeded that of most mutual funds year after year. But the S&P 500 is a portfolio of large-company stocks and is not well-diversified. An investor that held only an S&P 500 index fund during 2000 and 2001 saw his portfolio decline by 22%.
A simple diversified portfolio had dramatically different performance, down 1%, as the chart shows. That portfolio consists of 20% high-quality bonds and 80% U.S. stocks. The 80% is distributed among companies of different size: 50% large, 20% mid-size, and 10% small.
The diversified portfolio had remarkably low volatility during a very turbulent period. Its value was always within about 10% of its initial value.
Rising portfolio values are of course more satisfying than unchanged values. In comparison to severe losses, though, little change during tough market conditions has been very beneficial for investors with diversified portfolios.