Diversification Through Time – 2023

By Schultz Collins Investment Counsel on February 28, 2023

In previous articles, we presented insights from our core document, The Benefits of Diversification, which helped investors understand how diversification can reduce risk in their portfolios, and, when done right, can also help investors efficiently trade risk for return.  

In this article, we will continue the demonstration by examining Diversification Through Time. We will illustrate how, over time, a diversified portfolio will generally have a better reward-to-risk tradeoff than the individual constituent asset classes. That when considering time, it may require a period of five years or more to see a better reward-to-risk tradeoff. And how, irrespective of market conditions at the start of a portfolio, over time the benefits of diversification can be realized.

This idea is best explained through a video format, which is available above. We encourage you to watch the video. This article will show the concepts using a series of charts.

We will explore performance in terms of risk and return utilizing a 70-30 Model Portfolio that is comprised of 70% equity (stock) and 30% fixed income (bonds). We will explore how the risk and return characters of the Portfolio change over time by looking at series of charts that span the time periods of 1995 to 2022, 2000 to 2022, and 2005 to 20022. As we review each of the three time periods, the interaction of three key dimensions: return, risk and time will be revealed. 

To familiarize you with the charts, we will begin by looking at January 1^st to December 31^st, 1995, as seen in Figure 1. The horizontal axis measures risk using standard deviation. The vertical axis measures the compound annual return.  

Figure 1 

Data provided by Morningstar as of 2/21/2023. For illustrative purposes only. 

The chart shows a diverse set of asset classes across global equities with various US equity asset classes represented by colored circles and international equity asset classes represented by colored diamonds. Global, short-term, and intermediate-term fixed income asset classes are represented by colored triangles, and US Securitized Real Estate is represented by a brown circle.  

Of particular interest is the solid black line connecting the grey square, representing the risk-free rate as proxied by T-Bills, with a purple square, representing the diversified 70/30 Model Portfolio. The steeper the upward slope of the line, the better the reward-to-risk tradeoff for the Portfolio. Asset classes plotting above the line had better risk-adjusted returns, while assets plotting below the line had worse risk-adjusted returns for the period. Notice that the individual asset classes are disbursed with close to half of the asset classes plotting above the line and half of the asset classes plotting below the line.  

Now let’s look at the changes as we continue through time, as seen in the four charts of Figure 2. The top left chart shows 1995, which was already presented in Figure 1. The top right chart shows the two-year period of 1995 to 1996, which shows a few asset classes have moved below the line. Continuing to the three-year period of 1995 to 1997, as shown in the bottom left, there is movement in the risk-reward profile of the asset classes, but the same number continue to be above the line. When looking at the four-year period of 1995 to 1998, in the bottom right chart, we see that only two asset classes remain above the line. 

Figure 2 

Data provided by Morningstar as of 2/21/2023. For illustrative purposes only. 

Now let’s look at the changes as we continue through larger timespans, as seen in the six charts of Figure 3. The chart positions correspond to the following time frames: 

• Top left chart shows 1995 
• Top middle chart shows the 5-year period from 1995 to 1999 
• Top right chart shows the 10-year period from 1995 to 2004 

• Bottom left chart shows the 15-year period from 1995 to 2009 
• Bottom middle chart shows the 20-year period from 1995 to 2014 
• Bottom right chart shows the 28-year period from 1995 to 2022 

As we explore longer time periods, we see that some of the asset classes that were above the line move below and vice versa. As we continue, we notice that over time the number of asset classes above the line continues to decrease. Additionally, over time the changes in the slope of the line become more gradual from chart to chart. 

Ultimately, in the bottom right chart, all asset classes fall below the line with a few that plot on the line. We see that the 70/30 Portfolio has a reward to risk tradeoff that equals or exceeds that of each individual asset class. 

Figure 3 

Data provided by Morningstar as of 2/21/2023. For illustrative purposes only. 

Next, we will review the 23-year period from January 1, 2000 through December 31, 2022, as seen in the six charts of Figure 4. The chart positions correspond to the following timeframes: 

• Top left chart shows 2000 
• Top middle chart shows the 5-year period from 2000 to 2004 

• Top right chart shows the 10-year period from 2000 to 2009 
• Bottom left chart shows the 15-year period from 2000 to 2014 
• Bottom middle chart shows the 20-year period from 2000 to 2019 
• Bottom right chart shows the 23-year period from 2000 to 2022 

Notice that in the year 2000, the Portfolio return is negative and the line connecting the risk-free rate, depicted by the grey square, and our 70/30 Model Portfolio, represented by the purple square, begins with a downward slope. In this case most individual asset classes initially plot above the line. 

In the 5-year period, the portfolio has positive returns, the line slopes upwards, and we begin to see more individual asset classes below the line. As we continue through time, we see most individual asset classes falling below the line and the Portfolio demonstrating a reward-to-risk trade off that predominately exceeds each of the individual asset classes. 

Figure 4 

Data provided by Morningstar as of 2/21/2023. For illustrative purposes only. 

The last time period we will examine is shown in Figure 5. The five charts illustrate the 18-year period that begins January 1, 2005 and continues through December 31, 2022. The positions of the charts correspond to the following timespans: 

• Top left chart shows 2005 
• Top middle chart shows the 5-year period from 2005 to 2009 
• Top right chart shows the 10-year period from 2005 to 2014 
• Bottom left chart shows the 15-year period from 2005 to 2019 
• Bottom right chart shows the 18-year period from 2005 to 2022 

As we review this time period, do you see similar patterns as in previous periods? The slope of the line changes less when comparing longer timespans. Additionally, we continue to see the shift of more individual asset classes below the line over longer timespans. As time elapses, we see the Portfolio generally providing a reward-to-risk trade off that predominately exceeds each of the individual asset classes, just as we saw in the previous two time periods.  

Figure 5 

Data provided by Morningstar as of 2/21/2023. For illustrative purposes only. 

There are many factors that an investor should consider when constructing their portfolios, and this article demonstrated how, over time, a diversified portfolio will generally have a better reward-to-risk tradeoff than individual asset class constituents. We also saw that the time needed to reach this reward to risk tradeoff varied and may require a period of five years or more. And regardless of the starting market conditions, over time the benefits of diversification have been realized.  

It is important to note that this article is just an example of how we help clients. Furthermore, this Model Portfolio is not a recommendation, nor would we recommend prefabricated portfolios to our clients. Please reach out to us if you would like to learn more. Each person is unique, and we can help determine the allocation that best fits each individual’s needs and risk preferences.

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Disclaimer: Schultz Collins is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Some investment professionals may also be registered with Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC.  

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is neither indicative nor a guarantee of future results. The investment opportunities referenced herein may not be suitable for all investors.  

All data or other information referenced herein is from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other data or information contained in this presentation is provided as general market commentary and does not constitute investment advice. Schultz Collins and Hightower Advisors, LLC or any of its affiliates make no representations or warranties express or implied as to the accuracy or completeness of the information, or for statements or errors or omissions, or results obtained from the use of this information. Schultz Collins and Hightower Advisors, LLC assume no liability for any action made or taken in reliance on or relating in any way to this information. The information is provided as of the date referenced in the document. Such data and other information are subject to change without notice.  

This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates.