The meaning of Real Diversification

Amar Pandit , CFA , CFP

I had written a post about Diversified or Deworsified some time back. Many of you loved it and I got some interesting feedback.

I will not go very technical (or consider all nuances) in terms of Diversification here, but I wanted to share an insight that I have seen most investors ignore. Here it goes.

Real Diversification between asset classes or even within an asset class means that some investments might not do well at any point in time.

Digest this line and Reflect over it.

Many Investors expect every investment in the portfolio to go in ONE DIRECTION – UP. This is how we have been trained to think.

The moment some investments go in the opposite direction, they are called losers and an exit plan is made. Emotionally it is very difficult for someone to stick to an investment for several years while other investments are going up. An example, Pharma Funds did not perform for an extended period of time (around 4 years) but since 2020 they did a complete turnaround and have delivered a stellar performance. Similar is the case with Gold. When there is fear around, everyone wants to invest in Gold as was the case last year. However, gold did not deliver the kind of returns people were expecting it to in the last 1 year. Thus no one would want to invest in Gold now till the next cycle of fear forces people to do so.

I am not advocating investing in Gold. I am simply saying that a truly diversified portfolio will have performance divergences not only between asset classes but also within an asset class.

A reasonable expectation from a well-diversified portfolio should be for some investments to not do well for certain periods of time. Never exit an investment simply because it is not doing well. Have a conversation with your financial professional to see if the fundamentals of the underperforming investment have changed and the role that this particular investment plays in your diversified portfolio.