Why does a diversified portfolio commonly have a mix of different asset class exposure? Great question! Let’s explore that question and also look at 8 key investing indexes, that track popular asset classes, to see how they’ve performed recently.
What Is An Asset Class?
Investopedia defines an asset class as “a group of securities that exhibits similar characteristics, behaves similarly in the marketplace and is subject to the same laws and regulations.”
Why Different Asset Classes?
As you’ll see lower in this article, asset classes can perform drastically different in any given year. Because of this it can be helpful to select several different asset classes as components of your diversified investment portfolio.
Here are a couple reasons for this common practice:
Further Portfolio Diversification
You can invest in an S&P 500 Index and be diversified. In that situation your money will be spread across approximately 500 different publicly traded companies – not bad.
BUT, you will be 100% invested in large US companies, and completely in stock.
You can further diversify by adding more asset classes to the mix. Perhaps by adding some bonds, real estate exposure, international company stocks, or energy-focused investments.
Enhancing Investment Returns
Which asset class performs best one year isn’t guaranteed to perform best the next year. In fact, from our sample below there was only one index that was a top performer two years in a row. None performed the best for three straight years.
Mixing up the investments provides an opportunity to enhance your overall portfolio return potential.
Reducing Portfolio Volatility
An interesting thing about asset classes: Some move in opposite directions.
Let’s take the class example of stocks and bonds. When the stock market is doing really well, bonds tend to under-perform. But when a bear market cycle swings through and stocks take a hit, bonds tend to drop much less – sometimes even gaining.
Real estate is another interesting class. When inflation jumps it can sometimes have a negative impact on the stock market. But at the same time inflation tends to increase real estate prices. So it’s not uncommon for those two indexes to provide some balance to each other.
Indexes That Track Asset Classes
There are several indexes that track asset classes. For the purpose of this article I’ve selected eight key index from Vanguard to use as examples. I’m not recommending these specifically – just using them to get a feel for how different sectors have performed over the past ten years.
Here are the index funds I chose to report:
- Large Cap: VV
- Mid Cap: VO
- Small Cap: VB
- Foreign markets: VEA
- Emerging markets: VWO
- Real Estate: VNQ
- Energy: VDE
- Bonds: BND
An Interesting Thing About Foreign Indexes
Many people don’t understand foreign or international funds. A common assumption is that those funds are loaded up with companies no one in the US has ever heard of.
That’s not necessarily the case.
For the Vanguard VEA fund specifically, included in the top-10 holdings (as-of April 2018) are:
- Royal Dutch Shell (yes, those Shell gas stations you see)
- Samsung (they make great TVs!)
- Nestle (yum!)
- and more!
You see, there are a lot of brands we consume here in the US that are produced by non-US companies.
Interesting fact, right?
How Have These Indexes Performed Recently?
If you came looking for a chart, here it is: (Click on the image to open a larger PDF version)
Where Is The Consistency?
Wouldn’t it be nice if a single asset class just performed best all the time? When we could all just invest our money there and leave it alone forever.
Unfortunately that isn’t the case.
Emerging Markets has been both a top performer and a bottom performer. Same with Energy.
Large Cap Stocks, similar to the S&P 500 Index, in the past 10 years at least, hasn’t been the best or the worst performer.
Having a diversified portfolio across various asset classes – planned properly – can help lower portfolio value swings, and possibly enhance your overall returns.
What Do You Think?
Does this help clarify different asset classes and why professional investors often balance several different ones into their portfolios? Do any of these returns surprise you?
If you’d like to chat about your current investments to see if you are invested appropriately for your risk tolerance, while optimizing returns for your goals, let’s talk. You can see how to reach me from our contact page or you can schedule a call here.