Diversification

Every publicly traded stock falls into one of four major asset classes:

  • US Large Company
  • US Small Company
  • International Large Company
  • International Small Company
Annualized Return / Asset Class Performance by Decade

As you can see from the above graph, different asset classes tend to do well or do poorly at different times, independently of one another. Such groups are referred to as non-correlated asset classes. Note that a particular asset class may lead or lag the others for extended periods of time. So rather than make a bet on which asset class may be the best over the next stretch of time, intelligent investors diversify their portfolios broadly by including all of these asset classes in their portfolios. Doing so results in a portfolio that has a much higher probability of achieving the expected return.

It is also important to note that intelligent investors do not look to sell or remove "under performing" asset classes from their portfolios. If anything, investors should look to periodically rebalance their portfolios by selling shares of appreciated assets and reinvesting the proceeds in any beaten-down assets. This is the surest way to ensure the overall portfolio remains diversified.

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