Question: If, over the long run, the S&P 500 will return 9% or 10% per year, and I have a very long investment horizon (say, 10+ years), am I not better off simply placing my money in an S&P 500 index fund, which will likely outperform a diversified portfolio? Yes, I’m aware of market volatility and the risk that equities can go into prolonged slumps, but even if the investment began in 2007, the return would have been great. What am I missing?
Ric: You’re assuming that a diversified portfolio will earn less than the stock market over long periods. That’s not necessarily true. Keep in mind that a diversified portfolio is designed to reduce risk (volatility), not return.
History shows that in many 10-year periods, a diversified portfolio earns as much as the S&P, but does so with less risk. Meanwhile, many people who claim they can tolerate prolonged stock market slumps discover they really can’t. Just ask all the folks who sold in 2008 as the markets fell.
But if you are certain that you have both a long time horizon — 10 years or more — and a very strong stomach, we have no problem with your owning a pure stock portfolio.
But be forewarned: In our experience, the person who claims to have both turns out have neither.
When that market downturn comes, they realize they don’t have the strong stomach they thought they had, forcing them to sell low, with big losses.
Or something comes up in life unexpectedly — a marriage, a child, a job loss or a medical issue — causing their long-term horizon to evaporate. Millions, for example, lost their jobs in 2008, forcing them to sell their investments so they could pay their bills.
They didn’t plan to sell but found themselves with no choice — again, ruining their plans to stay invested for the long term.
For these reasons, people who don’t start with a diversified portfolio often later wish they had. Maybe you too.
Investing strategies, such as asset allocation, diversification, or rebalancing, do not assure or guarantee better performance and cannot eliminate the risk of investment losses. There are no guarantees that a portfolio employing these or any other strategy will outperform a portfolio that does not engage in such strategies. Funds and ETFs are subject to risk, including loss of principal. All investments have inherent risks. There can be no assurance that the investment strategy proposed will obtain its goal. Past performance does not guarantee future results.