Diversification is the key to eliminating asset-specific risk from a portfolio. As this article
points out, a diversified portfolio will never have the highest return
in any particular short-term period. In fact, on average, a diversified
portfolio should have middle of the road performance over a short period
such as a month. However, as the results of this article show, over the
long-term, a diversified portfolio can actually outperform many of the
individual assets in the portfolio without the increased level of risk.
In this case, from September 2003 to May 2013, a $10,000 investment
would have grown to $19,860 if it were invested in the S&P 500. Over
the same period, the investment would have grown to $24,199 in a
diversified portfolio.
We should note a couple of caveats.
First, the hypothetical portfolio in this example was rebalanced
monthly. In other words, whatever the beginning portfolio weight at the
beginning of each month, the portfolio was readjusted at the end of the
month so that the original portfolio weights were restored. While
rebalancing is important, a longer rebalancing period, say a year, is
probably preferable. Second, while we strongly believe in
diversification (And our own portfolios prove it!), the portfolio chosen by the author is aggressive and is not suitable for all investors.
