The value of long term asset diversification, sometimes known as “the only free lunch on Wall Street” is discussed in a recent MarketWatch article offering “Five Steps to Beating the Market.” “Stock investors typically regard ‘the market’ as essentially the Standard and Poor’s 500 Index of large U.S. growth stocks.” The article tracks and summarizes financial performance records since 1928 for large-cap blend the (S&P 500), large-cap value, small-cap blend, small-cap value stocks and a four-fund combination of these asset classes. In every summary, the four-fund combination produced a superior return to the S&P 500 alone. However, the price investors pay for higher performance is higher volatility. “For patient investors, those temporary losses are a relatively small price to pay for tripling the long-term return.”
The following “five ways to beat the market” are drawn from the data the tables below. According to the article, investors should realize:
- Outcomes are not predictable at the outset.
- Longer time periods make more dependable returns.
- The correlation between levels of risk and expected return may be less clear with a diverse portfolio over long investment periods. “When you compare the worst 40-year periods, you find that two of three other asset classes (SCB and SCV) had not only higher average returns but also better worst-case returns.”
- A diversified portfolio has a higher probability of meeting or exceeding 10% long-term returns. “Two of the other three asset classes, plus the four fund combo, had no 40-year periods at all with returns less than 10%.”
- “Wall Street tries very hard to convince investors they can beat the market by hiring ‘the right manager’ to choose stocks,” but the article suggests that “beating the S&P 500 index doesn’t depend on a manager. It’s the asset classes that do that.