Diversification Works in Bad Markets
For the entire history of the Dow Jones Industrial Average (Dow), investors have suffered 14 of the 20 largest point drops since 2008. The large numbers are partially because the Dow reached its all time high of 14,164.53 on October 9, 2007, and partially because market volatility is so high.
Investors have not been rewarded for this volatility as the stock market is now more than 20% below its high, and have responded recently with outflows from mutual funds – the “…steepest drop since the financial crisis.” (Source: Wall Street Journal, Aug 11, 2011)
What to do? Though the average loss from the 14 largest point drops of the Dow was 5.68%, the average loss from an equally-weighted diversified portfolio of 7 core assets of US and non-US stocks and bonds, cash, real estate and commodities was only 3.53%.
Diversification shielded investors from roughly 40% of the market drop.
Over the following two years from each down day measured, diversified investors earned on average 88% of the Dow back. Net result? Diversified investors lost less on every down day measured, and delivered nearly the same net returns after the recovery.
Conclusion? Risk ≠ Reward. Diversification lowered risk on the worst days but did not lower the net returns after the recovery. Risk was lowered – not returns. Do yourself a favor. Diversify now. — Andy Martin
(Source: MartinMetrics, Wall Street Journal, Market Data Center, Yahoo Finance, Adjusted closes, end date, 2 years after, and Morningstar, Inc. 7 assets portfolio was an equally-weighted all index portfolio.)
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