One of the giant on-line brokers, Fidelity, publishes many help articles, one of which is titled:
“The pros’ guide to diversification, Find out why diversification makes sense, and how to maintain it.”
The article can be read HERE.
Here is Fidelity’s explanation of diversification:
“The goal of diversification is not to boost performance—it won’t ensure gains or guarantee against losses—but it can help set the appropriate level of risk for an investor’s time horizon, financial goals, and tolerance for portfolio volatility.”
I don’t know how one determines “the appropriate level of risk for an investor’s time horizon, financial goals, and tolerance for portfolio volatility“. That certainly is a mouthful, but for our purposes, the time horizon is your lifetime and the risk tolerance is very high because you know the market’s history (See History is on Your Side).
This is because by the time you are ready to retire, you will have accumulated considerable wealth and it won’t matter where the market is because you will still be in it for 17 years and you KNOW the market will come back – as it has always done. And furthermore, you will not be withdrawing everything at once; instead little bits at a time.
VTI Only Beats Diversification again.
After only 16 years, the performance of this retirement fund falls way behind that of VTI and it will only get worse as the managers of this fund gradually reduce the ratio of stocks to bonds. By design, retirement funds increase the percentage of bonds in the portfolio as the owner gets closer to retirement.
The above diagram from Fidelity, covering the period from September, 2000 through January 1, 2016 illustrates my point. The fund, Fidelity Freedom Fund 2040 is a highly diversified “target’ fund designed for someone who will retire in 2040. This is a 40 years investment horizon.
VTI MAY have been more volatile, but it’s total value NEVER dipped below the value of the diversified portfolio! And look at the difference in performance 16 years after the inception of FFFFX. Look at the recession dip in 2009. Being diversified did not prevent FFFFX from experiencing the same devastating decline that VTI did.
Remember, this is a portfolio designed and developed by a giant online broker!