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The Case for Diversification

The Case for Diversification

October 14, 2020
Since COVID-19 first began to impact the U.S. and global stock markets earlier this year, many investors have seen their portfolios embark on quite the wild ride. When the S&P 500 reached what was then a new all-time high on February 19th, 2020, few if any would have guessed that just twenty-one trading days later the index would be in bear market territory, having fallen more than 20% during that time period. When the S&P 500 eventually bottomed on March 23rd, it had slid approximately 34%, and many other widely known global stock market indices, such as the Dow Jones Industrial Average and Russell 2000, had fallen by an even greater amount.

While the major global stock markets were experiencing this bout of downward volatility many bonds, especially high-quality bonds, were doing the exact opposite. On March 3rd, the Federal Reserve Bank cut the federal funds rate by 50 basis points, and then on March 15th, cut it again by 100 basis points which pushed the rate to a targeted range of 0-.25%. The reason this is important is because in general, interest rates and bond prices have an inverse relationship - when interest rates fall, bond prices go up. Conversely, the reverse is true - when interest rates rise, the price of bonds fall.

As evidenced by the chart below provided by JPMorgan, having a well-diversified portfolio consisting of a blend of the S&P 500 Index and the Barclays U.S. Aggregate Index not only dropped less in value during the market decline, but was able to recover the drop in value more quickly. This matters to many investors, our clients included, who rely upon withdrawals from their portfolio as a significant portion of their retirement income plan. Having a diversified portfolio of stocks and bonds that can help to mitigate downturns in the market also helps manage investor behavior.  This is because if the drops in value can be reduced, investors are less likely to panic and sell their investments at the exact wrong time.
Managing risk to the downside of one's portfolio is in our opinion, a critical component of sound portfolio construction. We all know that trees do not grow to the skies and that when (not if) there is a stock market downturn like we experienced this year, having a well-diversified portfolio has typically been a good tool to help mitigate the drop in value. Helping our trusted clients and friends understand the risk that they are taking in
 their portfolios and why we strongly believe in diversification is an important conversation that we will continue to have during our review meetings as we keep Moving Life Forward together.
*Investors cannot directly invest in indices. Past performance does not guarantee future results.
*A diversified portfolio does not assure a profit or protect against loss in a declining market.