Lessons from the 'quilt chart'
Focus on the big picture
If there's something in your portfolio that you dislike, it's a good sign it may be diversified. Nobel Laureate Harry Markowitz famously said that diversification is "the only true free lunch in investing," but the truth is that it's not entirely free: the cost is discomfort.
As you can see from the "quilt chart1" above, individual asset classes took turns being the "hero" or the "villain," but the overall performance of the moderate diversified portfolio fell somewhere in between. This is why diversification can feel uncomfortable, especially during the "good times" when your portfolio appears to be missing opportunities.
The key is to focus on the investment strategy of your whole portfolio rather than trying to fine-tune its individual pieces. By design, a well-diversified portfolio seeks to perform based on your investment objectives and risk tolerance, which can range from conservative to aggressive. It's far easier to calibrate your expectations around your long-term portfolio performance as a whole, rather than make decisions based on the randomness of individual asset classes' short-term returns.
- Diversified portfolios are built using asset classes driven by different underlying forces, so they aren't perfectly correlated with one another.
- These non-correlated asset classes' returns increase and decrease at different times, so the effect of extreme good returns in one asset class may be tempered by modest or negative returns in another.
- Diversified portfolios will always underperform their best performing asset class, so often there will be something in your portfolio that seems like "a loser" over the short-term.
- The portfolio's return will frequently fall in the middle of the pack—not the best, not the worst—making it feel like the portfolio may be missing opportunities.
- Despite these frustrations, it's important to remember that diversification is still a viable investment approach over multi-year (and even multi-decade) time frames.
Are you diversified? Have a conversation with your UBS Financial Advisor today.