Investing Lesson 10: The Diversification of Risky Assets is as Important as Ever
Larry Swedroe, Director of Research, The BAM Alliance, 1/29/19.
Lesson 10: The world isn’t flat, and the diversification of risky assets is as important as ever.
The financial crisis of 2008 caused the correlations of all risky assets to rise toward 1. This led many in the financial media to report on the “death of diversification”—because the world is now flat (interconnected); diversification no longer works. This theme has been heard repeatedly since 2008.
Yet diversification benefits come not just from correlations but the dispersion of returns as well. And wide dispersion of returns in almost every year since 2000 demonstrates there are still large diversification benefits.
Note that there were only three years of the 19 when the difference in returns between the S&P 500 Index and the MSCI EAFE Index was less than 5%. On the other hand, there were 10 years when it was at least 8%. There were also only three years when the return on the S&P 500 Index was within 10% of the return on the MSCI Emerging Markets Index. There were seven years when it was at least 20% and three when it was at least 30%. The largest gap was more than 53%.
The data presents pretty powerful evidence both that the investment world is far from flat and that there are still significant benefits in international diversification.
- Investing Lesson 1: Active management is a loser’s game
- Investing Lesson 2: Diversification is always working; sometimes you like the results and sometimes you don’t
- Investing Lesson 3: The mistake of recency
- Investing Lesson 4: Your Discipline Will Be Tested
- Investing Lesson 5: The Stock Market and the Economy are Different
- Investing Lesson 6: Crystal Balls are Cloudy
- Investing Lesson 7: “Sell in May and go away” is the financial equivalent of astrology
The BAM Alliance is an active community of more than 140 independent firms dedicated to delivering true wealth management. As Vermont's only member of the BAM Alliance, Copper Leaf Financial is very pleased to have access to all of the organization's resources and industry thought leaders including Larry Swedroe. Larry is the well-respected author of 16 books on personal finance, and has at times shared his insights directly with Copper Leaf clients.