In the world of investment, a diversified portfolio has long been heralded as a key strategy for managing risk and achieving stable returns over the long term.
However, the last few years diversified portfolios have not been doing their job properly. They haven’t been managing risk and the returns have been unstable.
This unexpected turn of events has left investors scratching their heads and re-evaluating their understanding of diversification. In this article, we delve into the factors that have contributed to the lacklustre returns from diversified portfolios and explore potential strategies for navigating these challenging times.
What has caused poor returns from diversified portfolios?
One of the primary culprits behind the underwhelming performance of diversified portfolios in recent years is heightened market volatility and uncertainty.
Remember the idea behind a diversified portfolio is that you buy different types of assets such as equities (shares in businesses), bonds and property. These assets all perform differently in different economic environments. When the conditions cause one type of asset to go down in price the same conditions could be good for an alternative asset which then might go up in price.
Various global events, such as the pandemic, war in Ukraine and geopolitical tensions, have generated significant market fluctuations. These abrupt shifts can disrupt the delicate balance that diversification seeks to achieve by causing multiple asset classes to move in tandem, effectively reducing the benefits of diversification.
The sudden and sharp rise in interest rates have been bad news for all assets apart from cash.
Bond prices of old bonds offering lower interest rates have fallen as investors sell and look for new bonds offering higher interest rates.
Higher interest rates mean it’s more expensive for companies to borrow and their business valuations are lower which hits share prices.
Another contributing factor to the poor returns of diversified portfolios is the overwhelming dominance of technology stocks. The past few years have witnessed an unprecedented surge in the tech sector, with a handful of companies driving the majority of market gains. While these tech giants have enjoyed meteoric rises, their valuations have reached lofty heights, causing concerns of a potential bubble. The heavy concentration of these stocks in major stock markets can lead to overexposure and undermine the diversification efforts of investors who rely on broader market investments.
The dynamics of the market itself have evolved, further complicating the performance of diversified portfolios. Algorithmic trading, passive investing, and the rise of index funds have altered the traditional market landscape. These trends can lead to scenarios where assets become linked in ways not previously seen, as market movements are increasingly influenced by investor sentiment, automated trading strategies, and mass investment flows.
Navigating through poor returns from diversified portfolios
While the last few years have indeed presented challenges for diversified portfolios, there are strategies that investors can employ to mitigate the impact of these factors:
- Reassess Portfolio Allocation: Investors should regularly reassess their portfolio allocation to ensure that it aligns with their risk tolerance and investment goals. This might involve rebalancing the portfolio to reflect changing lifestyle circumstances.
- Broaden Diversification: Investors can look beyond traditional asset classes and consider alternative investments that might exhibit different behavior during market turmoil.
- Risk Management: Implementing withdrawal risk management strategies, such as holding enough cash for your next 1-3 years spending can ensure you don’t need to sell units and shares during periods of low returns.
- Long-Term Perspective: It’s important to remember that even though recent years might have been challenging, a diversified portfolio’s benefits often shine through over the long term. Staying focused on long-term goals can help investors weather short-term volatility.
Diversified portfolios are no guarantee of future success but over the long term they have proven very resilient and good returns will certainly come again. The market has never permanently declined.
There have been many times during the past where all assets have delivered low returns in sync. The current poor returns are nothing new and more a feature of investing.
What a diversified portfolio does do though is allow investors to make good returns over the long term with less volatility on average.
Stopping investors from selling low and buying high has to be a good thing.
It’s not just the portfolio that is important for success. You need the right plan for your objectives and to determine a level of risk you are comfortable with.
If you are not sure what to do with your personal and workplace pensions at retirement then please get in touch for a free no obligation 15-minute call. We would be happy to review your position, explain where you stand and what you need to do to get the outcome you desire. We have created hundreds of happy retirements over the years. This could be you too.
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.