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The Lure of Narrow Markets
In the first six months of 2023, NVIDIA, a leader in artificial intelligence computing, had a stock price that was up over 100%1 and money markets were yielding over 5%.2 In addition, the S&P 500 is up almost 20.8% through the end of November.3
Large technology giants significantly outperformed other sectors, creating what’s known as a narrow market. A narrow market is a scenario in which market performance is driven by a small subset of companies while most others lag.
During narrow markets such as this, it is easy to wonder, “Why would I invest in anything but money markets, NVIDIA, or large tech stocks?” The appeal of straying from diversification principles is enticing and can cause investors to make emotional decisions. However, it is at these moments that Roehl & Yi believes it is essential to remain focused on the long term and maintain a portfolio that is well allocated across asset classes.
As the S&P 500 vs. Diversified Portfolio chart below illustrates, diversification can be painful, though it can produce consistent results over time.
Four Reasons Diversification May Improve Outcomes
1. Crystal Balls Are a Myth
The reality is that no level of brilliance, research, or conviction can inform exactly what is going to happen next. This is a lesson that, as humans, we are constantly re-learning. In early January 2020, we were not predicting that a pandemic was going to disrupt the world, halting economies across the globe. While there are many other less dramatic examples, such as speculation about how the Federal Reserve will manage interest rates, or how congress will handle our national debt, none of us knows exactly what decisions will be made in the next six months. The list of unknowns is infinite, and diversification is an acceptance of this fact that offers both a way to protect on the downside and benefit on the upside.
2. Diversification Lowers Portfolio Volatility Over Time
When a particular stock or asset class is going up, it is easy to forget that what goes up can also come down. While the returns of a portfolio that was invested 100% in NVIDIA were appealing in the first half of 2023, few would have been able to stomach the volatility of having their portfolio value go down 50%, which is what happened to NVIDIA stock in 2022.4 In addition, when a portfolio goes down 50%, it must come back 100% to reach its former value.
As depicted in the 15-Year Investment Performance chart below, diversification allows investors to lower volatility relative to returns, while enjoying reasonable returns over time without the pressure of selecting a single investment that will act as their golden ticket.
3. A Well-Diversified Portfolio Allows You to Participate Without Attempting to Pick Top Performers at a Moment in Time
As demonstrated by the 15-Year Investment Performance chart, by allowing for participation through various market sectors, the diversified portfolio produces compelling returns relative to the volatility level of the portfolio over time.
4. Diversification is Proven to Work
Diversification is the only “free lunch” in investing and is an important means to reduce overall portfolio volatility and improve returns over time. A well-diversified portfolio across asset classes provides a “smoother ride.” Downside protection and loss aversion are key considerations when selecting investments and building portfolios.5
In Closing
There are countless expressions regarding the importance of diversification in our lexicon, such as “don’t put all your eggs in one basket.” Unsurprisingly, the same is true of your investment portfolio. Limiting volatility is essential to meeting long-term financial goals. Diversification works and our philosophy is to construct all-weather portfolios, robust enough to navigate varying market environments so that you meet your financial goals.
About Roehl & Yi
Together, co-founders Tom Roehl and Jayman Yi, along with their qualified team of experienced personal wealth advisors, have more than 100 years of combined financial planning and investment experience. Our knowledge spans retirement plan management and consulting, complex financial analysis, estate planning, business formation, trading, and ass et allocation best practices.
Contact Roehl & Yi Investment Advisors to assist you.
1Morningstar.com, https://www.morningstar.com/stocks/xnas/nvda/trailing-returns
2Schwab, Pershing, PIMCO, Vanguard as of 9/7/2023
3Bloomberg, FactSet, MSCI, NAREIT, Russell, Standard & Poor’s, J.P. Morgan Asset Management
4Morningstar Direct
5Roehl & Yi Investment Principles
Roehl & Yi Investment Advisors, LLC (“Roehl & Yi”) is an SEC-registered investment adviser located in EUGENE, OREGON. This publication should not be construed by any consumer or prospective client as Roehl & Yi’s solicitation or attempt to effect transactions in securities or the rendering of personalized investment advice. A copy of Roehl & Yi’s current written disclosure statement as set forth on Form ADV, discussing Roehl & Yi’s business operations, services, and fees is available upon written request. Roehl & Yi does not make any representations as to the accuracy, timeliness, suitability, or completeness of any information prepared by any unaffiliated third party, whether linked to or incorporated herein. All such information is provided solely for convenience purposes and all users thereof should be guided accordingly. We are neither your attorneys nor your accountants and no portion of this material should be interpreted by you as legal, accounting or tax advice. We recommend that you seek the advice of a qualified attorney and accountant.
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