Why You May Not Be Beating the Market Right Now
Even if it's not matching the S&P 500's recent heady returns, a well-diversified portfolio is still your best bet in the long run.

That the stock market hit new highs in July, less than six months following one of the worst market declines in a while, was surprising to most investors. The market shook off the Brexit vote like it was just an annoying fly, and it continues to charge through discouraging economic news and increasing global strife as if they didn't matter. So, it was inevitable that we began hearing from some clients wondering why their portfolios are underperforming Standard & Poor's 500-stock index, which is up more than 18% from its February low, as of July 27.
The inconvenient truth is that diversification is the reason behind their underperformance. It's inconvenient because these are the same clients to whom we have been incessantly preaching the virtues of diversification as the absolute key to positive long-term returns. It is times like these, however, when diversification is bound to disappoint.
Why Diversification Has to Disappoint Sometimes
The challenge for diversified, all-stock portfolios is this recent stock market surge has been narrowly concentrated in domestic, blue chip stocks, as it has been with the stock market rally of the last few years. So, if your portfolio is diversified among several different stock asset classes (i.e., small cap, international, emerging market, etc.), it is not likely going to achieve S&P 500-like performance. In fact, with an optimally diversified portfolio, you are likely to be disappointed with at least a third to as much as half of your portfolio at any particular time.

Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
It is also times like these, however, when you need to step back and take a long view of the stock market to remind yourself what diversification has helped you achieve in the past and what it is expected to achieve in the future. It is easy to view the market in hindsight and second-guess your strategy; it's not so easy to see and plan for what lies ahead. Diversification is recognition of that uncertainty, and it liberates us from the pressure of having to always be right. Diversification allows us to be vaguely right all of the time, while never being completely wrong. When considered in the long view, and with so much at stake, that's a winning proposition.
You Can't Invest With Hindsight
Consider the performances of S&P 500 stocks and emerging-markets stocks over the past decade. Investors with a diversified stock portfolio may complain that four out of the last five years, emerging market stocks, as measured by the MSCI Emerging Markets index, were a serious drag on S&P 500 stocks. During that period, the MSCI index averaged a negative 4% return, while the S&P 500 averaged about 13%. However, between 2004 and 2010, S&P 500 stocks, which averaged about 6%, were an even bigger drag on emerging-markets stocks, which averaged 25%.
The reality is a diversified portfolio captured the outperformance of both markets in their best years, while smoothing out the risk and volatility of both markets in their worst years. The purpose of a broadly diversified portfolio is to capture the returns of all of the sectors over time but with less volatility at any one time. It is also important to note that, over time, passively managed portfolios of stocks have outperformed actively managed portfolios that rely on market timing and individual stock selection.
Diversification Means Never Having to Say You're Sorry
The incessant noise and information overload we experience every day, which, by the way, can only impact short-term outcomes, does more to distort our reality of the long-view than provide us with any sort of advantage. When applied with discipline and patience, a thoughtfully conceived diversification strategy enables investors to ignore the noise and focus instead on their long-term objectives, which aren't impacted by what the stock market does in the first six months of the year.
By taking a step back to view your portfolio as a whole, and not by its parts, you get a much clearer investment perspective and a reminder of some of the fundamental truths of investing:
- the markets are random—it's impossible to time the market with any degree of consistency;
- risk and returns are related—adding higher-risk elements to your portfolio improves long-term performance, but they are mitigated through diversification;
- and over the long term, a diversified portfolio will yield higher returns while minimizing the risk of any single investment or market segment.
As an investor you need to ask yourself: Would you rather be mildly disappointed that a portion of your portfolio underperformed another, or massively disappointed that you guessed completely wrong by investing in a single market segment at the wrong time?
Craig Slayen is a principal at Cypress Partners., a financial planning and investment management firm in the San Francisco Bay Area.
Pete Woodring, a partner with Cypress Partners, contributed to this article.
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.

Craig Slayen is a principal at Cypress Partners., a financial planning and investment management firm in the San Francisco Bay Area.
The firm believes that the key determinant to long term financial success is based around three concepts: sound planning, prudent investing, and an awareness of the behavioral traps that can kill portfolio returns.
Craig is the author of Successful Investing for Female CEO's, published by Charles Pinot. He is a graduate of UC Berkeley.
-
Despite Economic Uncertainty, Americans Remain Confident About Retirement, Survey Shows
Saving and spending is a concern but most workers and retirees think they are on track based on a new survey.
By Donna Fuscaldo
-
Verizon’s Free iPhone Deal: What to Know Before You Switch or Upgrade
Verizon is offering a free smartphone — including the latest iPhones — with any myPlan, plus a three-year price lock. But is it really the best deal for you?
By Choncé Maddox
-
Before You Invest Like a Politician, Consider This Dilemma
As apps that track congressional stock trading become more popular, investors need to take into consideration some caveats.
By Ryan K. Snover, Investment Adviser Representative
-
How to Put Together Your Personal Net Worth Statement
Now that tax season is over for most of us, it's the perfect time to organize your assets and liabilities to assess your financial wellness.
By Denise McClain, JD, CPA
-
Bouncing Back: New Tunes for Millennials Trying to Make It
Adele's mournful melodies kick off this generation's financial playlist, but with the right plan, Millennials can finish strong.
By Alvina Lo
-
Early-Stage Startup Deals: How Do Convertible Notes Work?
Some angel investors support early startups by providing a loan in exchange for a convertible note, which includes annual interest and a maturity date.
By Murat Abdrakhmanov
-
SRI Redefined: Going Beyond Socially Responsible Investing
Now that climate change has progressed to a changed climate, sustainable investing needs to evolve to address new demands of resilience and innovation.
By Peter Krull, CSRIC®
-
Here's When a Lack of Credit Card Debt Can Cause You Problems
Usually, getting a new credit card can be difficult if you have too much card debt, but this bank customer ran into an issue because he had no debt at all.
By H. Dennis Beaver, Esq.
-
Going to College? How to Navigate the Financial Planning
College decisions this year seem even more complex than usual, including determining whether a school is a 'financial fit.' Here's how to find your way.
By Chris Ebeling
-
Financial Steps After a Loved One's Alzheimer's Diagnosis
It's important to move fast on legal safeguards, estate planning and more while your loved one still has the capacity to make decisions.
By Thomas C. West, CLU®, ChFC®, AIF®