In our latest edition of the Periodic Table of Asset Classes, we try to answer one question that arose from last year’s ashes: Does diversification still work? With all of the major equity asset classes being down for the year, the question is a fair one.
Diversification never has been and never will be a silver bullet to avoid losses. However, diversification does shelter a portfolio from the losses suffered by the worst performing companies, sectors or asset classes in any given period of time. So, as bad as the markets were, did diversification work for the year? The answer is clearly YES. The Periodic Table (CLICK HERE) shows the same asset classes that we have presented in the past with their respective performance for 2008.
As should be expected, fixed income was the best performer with a loss of 3% for the year. The equity asset classes ranged from a loss of 29% for domestic small cap value to a loss of 53% for emerging markets. At the end of the previous year, there were many investors who felt that international investing, especially emerging markets, was the best alternative for the future due to its recent superior performance and the potential for decoupling from the U.S. economy. The underperformance of international asset classes in 2008 not only supports the case for diversification, it also confirms the futility of market timing.
The most blatant evidence in favor of diversification, however, lies in the realm of individual stocks. Investors who made large bets on Freddie Mac, Fannie Mae, Lehman, AIG, Citigroup, Bear Stearns, General Motors or any of the other “too big to fail” stories of 2008 learned an expensive lesson about the risk of not properly diversifying.
While 2008 was a terrible year for all equity markets, it was far worse for many investors who failed to adhere to a diversified strategy. With huge volatility and “blue chip” companies going bankrupt, diversification is currently more important and more effective than at any time in recent memory.
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