Blogs & Comment

Investors and diversification

Ativa.com has some interesting calculators that show the impact of diversification during bear markets and bear/bull cycles. Lets take a look at them, as a supplement to my column onfinancial calculators. According to Activa’s diversification calculators, a portfolio diversified equally over stocks, bonds and cash during the bear market from September, 2000 to September, 2002 declined only -2.6%, whereas an all-stock portfolio tumbled -44.7%.
Unfortunately, during the bull market that ran to early 2008, many people thought they were diversified if they spread their 70% to 90% equity allocation by geography, industry, and market cap. So now diversification is taking a bit of an unwarranted rap on the knuckles.
Activa also has a calculator showing the impact of diversification over bear/bull cycles in the stock market since 1968. For the most recent cycle, from September, 2000 to May, 2008, Activas diversified portfolio finished 53% higher, while the all-stock portfolio finished 48% higher. The all-stock portfolio may have raced ahead during the bullish phase but wasnt able to compensate for the huge losses incurred during the bearish phase.
However, during the previous six bear/bull market cycles back to 1969, the all-stock portfolio ended up higher in four of them. So, being diversified doesnt always win. Whether you go with a stock-intensive or diversified portfolio would seem to be more a matter for risk preference. And of course time period is important too: it is generally believed stock-intensive portfolios would be suitable for young persons saving for retirement. Endnote: Activas calculator used total return U.S. indexes (and 10-year government bonds).