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| Diversification |
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Take the Guesswork Out of Investing
To create an optimal portfolio you need to do more than just determine the right mix of stocks, bonds, and cash. Broad diversification within each asset class is critical, especially given that the financial markets are constantly evolving and today's performance leaders may be tomorrow's laggards.
For instance, in 2002, bonds produced the best results, only to fall near the bottom of the list the very next year. An investor who avoided small- to midcap stocks because of their 2002 results, which ranked them near the bottom of the list, would have missed out on the strong performance in 2003 and 2004 when they outperformed most asset classes.1 By investing in a well-diversified portfolio, you avoid chasing returns and alleviate concerns about being in the right place at the right time.
Maintaining a Diversified Portfolio
A diversified portfolio is especially critical when you consider market declines. If an investment falls 25% in one year, it takes a 33% gain in the following year just to break even. By investing in a variety of market sectors and styles, a loss in one area may be recouped by a gain in another. For instance, during the 2000-2002 bear market, a portfolio consisting of only large-cap stocks lost nearly 40% of its value. In contrast, a diversified portfolio experienced less volatility, despite the steep stock market decline.2
A Diversified Portfolio's Performance Over Time2
Diversification can be advantageous in the short term as previously mentioned, but it has also been beneficial for long-term investors. A diversified portfolio obtained competitive returns, with less exposure to market risk than the large-cap stock portfolio, as evidenced by the chart below:
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