Asset Allocation and Diversification

It’s virtually impossible to predict which asset class will do well over a specific period of time. Sometimes different asset classes move together; sometimes they don’t. Some tend to move in the opposite direction from others. For instance, when the dollar weakens, international stocks tend to do better.

There have been long periods where certain categories of stocks experienced extraordinarily high returns. In the late ’70s and early ’80s, Small International Stocks really shined, boasting 70-80% returns each year. Then in the late ’80s, when Japan was booming, Large International Stocks did extraordinarily well. Next, in the early ’90s, Small U.S. Stocks did very well. In the late ’90s, it was Large U.S. “Blue Chips” Stocks. (“Blue Chips” are nationally recognized, financially sound companies. They are stable, and their growth tends to mirror that of the S&P 500.) The best way to diversify your portfolio is by investing in different financial instruments, and differently sized and valued companies.

Then the tech bubble burst in 2000. Then in the mid-2000s, the U.S. dollar dropped in value, and International Stocks (including emerging markets) did well. More recently, the housing bubble burst in 2008 and the market nosedived, but began making a comeback in 2009.

Many investors use Asset Allocation as a way to diversify their investments among asset categories.

To emphasize the importance of diversification and asset allocation over long periods of time, let’s look at a hypothetical example.

Imagine that you had one dollar to invest in 1926 that you would cash in in 2015.

● If you had invested it in Large Growth Stocks, that dollar would have increased to $3,530 in 2015.
● If you had put it into Large Value Stocks, it would have grown to $12,910.
● Investing in Small Growth Stocks would have yielded $14,580.
● In Small Value Stocks, that dollar would have grown to a whopping $139,000.

There’s a big difference in returns depending on how you invested that dollar.