A diversified portfolio will minimize your portfolio risk and to do so you will have to invest in different types of assets instead of concentrating your bet in a single asset class. The picture below shows the annual performance of different asset classes from 2008 to 2018, ranked from best to worst. Now try finding a pattern. Is there an asset class that is likely to perform better than the others in this year? How about next year?
There is clearly no pattern and that’s exactly the point I am trying to make. In different business cycles, different asset classes outperform others. It’s difficult, if not impossible, for even an experienced investor to identify ex ante the asset class that will win. This clearly shows that you need to diversify. In 2017, emerging markets outperformed all others. If you had bet all your money in 2018 on emerging markets, you would be down about 15%.
A diversified portfolio may not be the best performing portfolio, but it will certainly not be the worst performing portfolio either. You would be somewhere in the middle. That is the key to investment success. Consistently average returns on your portfolio should help you build your wealth in a slow and steady manner till you reach your goal – retirement or children’s education or a dream luxury vacation :). Remember, the slow and steady tortoise won the race. Don’t try to predict winners. It’s going to be a losing game.