Charting the Benefits of a Diversified Approach
American Century Investments
May 31, 2012
We’ve written quite a bit about diversification recently. Rather than tell you about the potential benefits of a diversified approach, we thought we’d use this initial issue of Chart of the Week to show you how a diversified portfolio can potentially smooth out performance and improve cumulative returns over time.
The chart shows the annual returns for 10 different asset classes, plus those of a diversified portfolio made up of those same assets in equal proportion. In other words, the diversified portfolio is 10% U.S. large-cap equities, 10% U.S. small-cap equities, 10% equities of foreign developed markets, 10% equities of emerging markets, and so on. Note that we don’t advocate allocating your own portfolio in this fashion; rather, we present these results purely to illustrate the potential benefit to be gained from combining many uncorrelated assets into a single portfolio.
There are a few key things to draw from the chart. First, note how the diversified portfolio moderates the performance of these widely divergent asset classes, never finishing in the top or bottom three in any year in our data set. Combining assets with different risk, return, and correlation profiles can be an effective way to reduce overall portfolio volatility.
Second—and we think this is crucial for investors to take on board—note that even though the diversified portfolio rarely finishes higher than fifth or sixth in any given year, the portfolio ranks third in terms of cumulative returns over the full time period. In part, this reflects the benefit to investors of reducing volatility—other things equal, given two portfolios with the same average annual returns, the lower-volatility portfolio will produce better cumulative results. In addition, it shows the benefit of systematic portfolio rebalancing—routinely selling winning assets to buy those that have underperformed. This strategy forces a buy-low, sell-high discipline so critical for investor success over time.
To read more about diversification and its role in your portfolio, click here.
For detailed descriptions of the indices referenced in this commentary, refer to our Glossary.
The Citigroup 3-Month U.S. Treasury Bill Index tracks the performance of U.S. Treasury bills with remaining maturities of three months.
The Citigroup Non-USD World Government Bond Index measures the performance of government bonds issued by governments outside the U.S.
Diversification does not assure a profit nor does it protect against loss of principal.
Investment return and principal value of alternative investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
The opinions expressed are those of American Century Investments and are no guarantee of the future performance of any American Century Investments portfolio. This information is not intended to serve as investment advice; it is for educational purposes only.
(c) American Century Investments