Is diversification dead?
As we settle into 2023, economists and analysts are still trying to answer last year’s two-part question: Is the economy still too strong - and is inflation too high, which means that the Fed will have to keep interest rates higher for longer?
The answer may help determine whether or not the economy slows substantially, prompting the U.S. to enter a recession.
The December jobs report showed how tricky the situation is for the central bank: The economy added 223,000 jobs, which indicates underlying strength in the labor market. But the Fed was likely heartened by the notable slowdown in wage growth to a 4.6 percent annual pace, the lowest since August 2021.
Against the Fed’s uncertainty is a nagging thought: What if this time really is different for investors?
As a reminder, 2022 was a terrible year for stocks and bonds. The S&P 500 fell 19.4 percent and the tech-heavy NASDAQ tumbled by 33.1 percent led lower by big tech names.
Unfortunately, there was no hiding in the bond market which suffered its worst year in decades, with the S&P aggregate bond index down 12 percent.
The 2022 results have prompted many in my podcast audience to ask whether diversification is dead or if last year proves that asset allocation does not work. Although I could not have anticipated the magnitude of the 2022 downturn, when I was writing my soon-to-be released book The Great Money Reset, I posed the following question: Conventional wisdom holds that passive or index investing is best. Is that still true in volatile times?
Here’s the answer, from The Great Money Reset:
“Darn straight it is. As I argued in my previous book, indexing (where you buy a fund that mirrors a specific asset index, such as the S&P 500 stock index or a bond or commodity index) really works, no matter what’s happening in the wider world.
“You might shake your head at this, objecting that you’re better off putting your money in the latest hot stock du jour. In 2021, that might have been Tesla, which during the decade after its founding saw its stock price rise more than 4,000 percent. How can the S&P 500 or some other boring old index possibly compete with that?”
[Side note: when I chose Tesla as the poster child for upside performance in the book, I could not imagine that 2022 would usher in a 65 percent LOSS for the innovative car company!]
“I’ll tell you how. None of us knows in advance how a given company will perform. To lower their risk, most active investors (people who buy and sell stocks on an ongoing basis hoping to outdo various indices) avoid investing in one company and instead buy a basket of stocks.
“When you do that, it becomes very difficult to outperform market indices over long time periods...The key to sound investing isn’t to be a genius, staying one step ahead of markets. It’s to not blow it by avoiding unforced errors. Don’t follow those who are looking for the next rocket-ship stock. Slow, steady and passive wins the day.”
A 2023 addendum: Last year was a grim reminder that diversified portfolios will come with good and bad years. But focusing on one horrible year can divert your attention from achieving long-term goals. Try to drown out the noise and focus on what you can control, like how much you spend and how much you save.
The excerpts are from the forthcoming The Great Money Reset by Jill Schlesinger. Copyright (c) 2023 by the author and reprinted by permission of St. Martin’s Publishing Group. Available for purchase at the retailer of your choice: https://www.jillonmoney.com/the-great-money-reset.
Jill Schlesinger, CFP, is a CBS News business analyst. A former options trader and CIO of an investment advisory firm, she welcomes comments and questions at askjill@jillonmoney.com. Check her website at www.jillonmoney.com.