Investors frequently grapple with one question: why does a diversified portfolio seem to underperform when the markets rise?
A diversified portfolio is not designed to be the star performer during a market surge. It’s built around the idea of providing steady returns regardless of market volatility.
This reliable performance is made possible through the inclusion of different types of assets such as shares, bonds and commodities like gold.
The dynamics of a market upswing
Consider a booming market where shares are soaring and delivering substantial returns – in some cases, as high as 25% to 35%.
If you’ve chosen to invest solely in shares, your portfolio’s growth rate would likely reflect this upward market trend. However, diversified portfolios – the ones that include bonds, gold and other asset classes – may not showcase the same high growth rates during such market booms.
The role of diversification in a market downturn
It’s during a market downturn that the true advantage of a diversified portfolio comes to light. Bonds and gold, unlike shares, can retain their value or even appreciate during these phases, acting as a cushion against falling share prices.
These stabilising assets allow your portfolio to remain protected even when the broader market is struggling. This phenomenon was vividly on display during the substantial market slump of 2020, where diversified portfolios managed to stay afloat despite widespread declines.
The notion of quality returns
Nevertheless, the presence of these protective assets can result in the overall portfolio growth lagging behind the market’s top performers during prosperous times. This is where the idea of quality returns offers a fresh perspective.
Quality returns aren’t about chasing the highest possible returns. Instead, it focuses on balancing the returns earned against the risk taken to achieve them. A portfolio concentrated in shares might yield high returns during a bull market, but the increased risk and volatility could undermine the value of those returns.
To put it into real-world terms, consider a high-growth portfolio that comprises shares, bonds and gold. While it might return around one to one and a half per cent less each year compared to a portfolio exclusively dedicated to shares, it offers significant protection during market downturns.
Recall the market downturn of March 2020 when the market plummeted by 35%; diversified portfolios composed of shares, bond and gold were able to limit their losses to much less than the market average.
“Diversified portfolios allow you to remain invested over the long-term
Embracing the slow and steady approach
While diversified portfolios might seem to underperform during periods of market prosperity, they offer something far more valuable – steady, reliable growth.
This consistency allows for sustainable wealth accumulation over the long-term. Rather than worrying about relative underperformance during particular boom years, investors would do well to focus on the compounding effect of stable, consistent growth over time.
Remember, if a diversified portfolio doesn’t top the charts during a bull market, it’s not a cause for concern. Rather, it’s an indication that the portfolio is operating exactly as intended – balancing risk and reward to ensure a smooth journey towards your financial goals.
Diversified portfolios allow you to remain invested over the long-term. Investing is a marathon, not a sprint. It’s not about reaching the finish line the fastest, but rather about staying the course for a rewarding journey.