August 4, 2023

If you’re an investor, odds are someone has taught you the benefits of diversification somewhere along the way.  I learned to diversify long before I was a financial advisor and I learned from my grandfather. 

My grandparents lived on a farm and raised horses.  This was super convenient as their farm was just down the road from a horse track and most of their friends were in the horse business.  On many a summer night, I went to the horse track with Pop Pop who explained that you could bet on one horse to win or you could bet on a few horses to win.  He pointed out that you may not win as much but winning something usually feels better than losing everything.

While I certainly wouldn’t compare a long-term investment strategy to betting a few bucks on a 75 second horse race, I know investors want to bet on the winner too.  Since that’s nearly impossible to predict from one year to the next, like my grandfather, most investors opt to spread their “bets” out across a variety of different investments. 

That brings us to measuring your “winnings.”  A common index that investors use to compare their own investment performance is the S&P 500, a group of the 500 largest companies listed on U.S. stock exchanges.  Sounds pretty diversified, right?

Well, in truth, the S&P 500 may not be as diversified as you think.  In fact, the index is currently concentrated in tech stocks and this year’s gains are almost entirely from just five companies (Axios, 6/1/23).  There are no bonds in the S&P 500, no small or medium size companies and no geographic diversification.  In other words, you’re putting a pretty large bet on one horse… big companies located in the U.S.

While investing in the S&P 500 is part of many well-diversified* portfolios, we caution investors against comparing their diversified portfolio performance against this concentrated index.  Most investors diversify across a variety of investments to reduce the risk of big losses.  But that also means that when one particular type of investment is winning big, your portfolio might look like it’s just trotting along. 

But in the long term, slow and steady wins the race.

*Diversification does not assure a profit or protect against loss in declining markets, and diversification cannot guarantee that any objective or goal will be achieved.