The Downside of Good Portfolio Diversification

One of the downsides of having a well-diversified portfolio is that you will always have “not enough” of what is outperforming and “too much” of what is underperforming. As I mentioned in my last blog, investors have a tendency to chase performance. Another casualty of this behavior is abandonment of diversified portfolios.

After a year where US equities have outperformed other asset classes by a significant margin, investors may be tempted to reduce or eliminate their allocation to other equity, fixed income, and alternative assets. We want to own more of what is “winning.” There is another description for this behavior: selling low and buying high! Investors may be getting out of asset classes before they go up and may be getting into an asset class as it is peaking. After all, if two asset classes have similar long term returns, after a year or two of significant outperformance by one, wouldn’t we expect a return to the mean?

A better plan would be to rebalance your portfolio back to its normal weightings. This way you can capture some of your gains (sell high) and add to your underweighted assets (buy low). Of course, past performance is no guarantee of future results and markets may behave very differently in the future. But I wouldn’t bet on it.

So, my friends, stick to your well-designed plan or check in with us to get a second opinion on it.