The Power of Portfolio Diversity

Portfolio diversity is good for you and your future.

It used to be very few people invested—about 11 percent of the population in 1959—and most of them speculated in the stock market. Buying stocks was (and is) more like gambling than real investing, as individual companies can go bankrupt, losing stockholders everything they invested.

But starting in the 1960s, better-educated workers discovered mutual funds as a way to increase wealth. The funds offered several advantages over buying individual equity securities. Since most stocks were only sold in “round lots” of 100 shares, buying shares in even one firm was beyond the means of most. Mutual fund portfolios were available to those with $1,000 or less to invest.

Mutual funds offered another huge advantage to investors—diversity. People could invest in a large segment of the economy and worry less about the possibility of total loss. Losing everything in a fund was still technically possible, but even in a fund with 20 or 30 stocks, it was far less likely.

So it’s no surprise mutual funds have become popular. In 1970, about 250 U.S. mutual funds were managing a mere $50 billion. That number has mushroomed to over 8,000 funds with more than $16 trillion invested. Globally, mutual funds manage more than $31 trillion.

Boomers were the first generation of Americans to have the opportunity to be what I call “real” investors, which I define as someone who understands that investing is not synonymous with speculating. These are folks who have learned that buying a stock or two (or even several) is far too dangerous to their future wealth.

No matter how good a company might be today and how confident you are in its prospects, it is impossible to know what the future will bring. Millions of investors rode General Motors (GM) stock from $93 per share in 2000 all the way down to worthless when the company filed for bankruptcy in 2009. In the 1960s the prevailing belief was that “as goes GM, so goes the country.” Thankfully, despite GM’s crash, the country goes on. (And so does GM: After its original shareholders lost everything, the company reorganized. The new GM stock trades for about $37 a share.)

If you bought $10,000 worth of GM stock in 1970, you would have nothing today. However, if you invested $10,000 in a diversified portfolio consisting of almost every publicly traded stock in the U.S., you would likely be sitting on over $1 million today. (This is a hypothetical example and does not represent actual past returns or imply any future results.)  A globally diversified portfolio would have done slightly better. Yes, you would have suffered through some frightening declines—like watching your $10,000 drop to about $8,000 in 1974 or your $500,000 plummet to about $300,000 in 2008—but, barring an asteroid strike or global nuclear war, there was no chance you could have lost it all. The same reasoning applies going forward: Portfolio diversity is good for you and your future.

 

The host of the nationally syndicated Don McDonald Show for over 20 years, Don now co-hosts Talking Real Money with Tom Cock on Seattle’s KOMO radio Saturdays at noon (talkingrealmoney.com). Don also publishes the investing magazine, real investing journal (realinvestingjournal.com).

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