Do Investors Still Need Diversification?

With any investment approach, it is crucial to have a plan, and the bedrock of any investment plan is to have a well-diversified portfolio among various asset classes. The rationale behind diversification is to mitigate risk, as you never know when something could adversely affect one of your investments. If you had a portfolio concentrated in equities in 2008 or in energy-sensitive securities following the recent drop in oil prices, you would have lost a significant amount of your investment value. As investors, we diversify portfolios to seek to reduce this risk.

090 (6)However, simply because diversification has been an effective way to potentially reduce risk over long periods of time, by definition you would expect it will outperform some years and underperform others. Unfortunately, this can be painful when the outperforming asset class is the most well-known U.S. index—the S&P 500, an index of the 500 largest U.S. public companies.

This is exactly what happened in 2014—the S&P 500 significantly outperformed many other often diversifying asset classes, including small cap stocks by nearly 9% and foreign developed stocks by approximately 18%. Therefore, a diversified portfolio last year would have significantly lagged the S&P 500.

So why not just invest in large cap stocks or the S&P 500? Over the past 20 years, the S&P 500 has only outperformed all other major asset classes (including small, mid, foreign developed, and emerging markets) 30% of the time, and it was the worst performing asset class 25% of the time. It is important to stick with your investment plan and be invested in at least several different types of investments. Diversification has historically worked, and as we look at 2015 so far, it may be starting to work again.

In 2015, we will continue looking for places to effectively diversify, and will be closely monitoring potential opportunities. In Europe, the European Central Bank is taking aggressive steps to stimulate its economy. As commodity prices stabilize, emerging markets could join the global growth trend. After decades, Japan emerged from deflation with a massive stimulus effort, which may continue to offer an investment opportunity. There are many potential opportunities on the horizon, and looking ahead, I believe returns may come from a much broader set of investment choices, which has already begun in 2015.

file5251307073889When it comes to investing, it is always important to monitor the risks. A key to risk management is a diversified portfolio. You may not always outperform the most well-known index that many undiversified portfolios emphasize, but that should not lead you to abandon your plan and chase the hot asset class. We remain committed to seeking to outperform in different investment climates, but doing so with a well-diversified portfolio that does not take on undue risk.

As always, if you have any questions, I encourage you to call me at (925) 464-7057 or email me at bill.pollak@lpl.com.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. Indexes are unmanaged and cannot be invested into directly.

Economic forecasts set forth may not develop as predicted.

All investing involves risk including loss of principal.

All indexes are unmanaged and cannot be invested into directly.

Because of its narrow focus, specialty sector investing, such as healthcare, financials, or energy, will be subject to greater volatility than investing more broadly across many sectors and companies.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform an undiversified portfolio. Diversification does not ensure against market risk.

Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

This research material has been prepared by LPL Financial.

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