Why ignoring diversification could cost you in the future

The US market and Tech are down from their peak this year, with the Nasdaq down 12% and the S&P 500 Index down 8%. Do you see a pattern? The broader the index, the less it has fallen. Europe and Hong Kong and China markets are not only positive but up by double digits. 

We saw double-digit gains in major US equity indices for two consecutive years, which made people complacent. The Nasdaq had only one correction of more than 10% in 2024 and two in 2023. Meanwhile, the S&P 500 did not see a single correction of 10% throughout 2024, and only once in 2023. 

Such a period of sustained, stable and concentrated gains drew many into building US-centric or even US-only portfolios. The talk of US exceptionalism reached fever pitch this year. Such peak sentiments should always raise some scepticism. When markets are in your favour, the strategy may seem bulletproof. Some say that diversification is dead and ask: Why spread your bets when the strategy was delivering such remarkable returns?

The recent market volatility is why, and it serves as a stark reminder of a fundamental truth. Diversification is not just a prudent strategy, it is your friend in the unpredictable world of investing. It helps us manage our volatile emotions and guide us to the right behaviour that increases our chances of survival and success in markets. 

The dangers of concentration

We know how we got here. Heavy investments and rapid adoption of AI have driven an insatiable appetite for chips and computing power and the stocks of companies behind them. Investor fervour for the Magnificent 7 has reached new heights of optimism that AI will drive massive productivity gains to justify everything, including the high valuations. 

While backed by strong growth, it is worth reminding ourselves that the markets move on the second derivative of growth - the delta - not the absolute amount of growth. Whether they are accelerating or decelerating in pace. Also, whether it is better than the market expectations. We have to assume that all known information including our expectations and market forecasts are priced into current markets. 

With stubbornly high inflation and borrowing rates, the hurdle for growth to compensate for higher cost is greater and few companies can overcome that hurdle. The fact that most of the companies that have delivered on growth have been heavily concentrated in the US and the tech sector is undeniable. 

However, we know looking back at the history of financial markets, solely relying on one sector, one country or region, exposes your portfolio to significant concentration risks, especially when that sector or region becomes crowded and expensive. 

As of a few months ago, the earnings revision for the Magnificent 7 stopped moving higher. In other words, the delta on the growth or second derivative stopped moving in our favour and thus became more vulnerable to a pullback. 

It is still relevant and true that most large US tech leaders have strong business and technology moats. Solid balance sheets and abundant cash flow allow them to sustain their dominance. It is also possible that they remain a core long-term holding and a meaningful part of any portfolio. However, if there is anything that we learn from the past, putting all our eggs in one basket and not taking advantage of opportunities to diversify often hurts us at critical moments. 

Diversification lessens the impact of falls in markets 

Diversification means gaining exposure to other sectors, regions, asset classes to minimise volatility of outcomes or to enhance long-term risk-adjusted returns. While everybody focuses on the upside, one should also be cognisant of the potential risks, and we know that managing risk, especially in downturns, is a critical way to preserve our capital and allow long-term compounding of returns. 

Looking at all the corrections since March 2020 suggests that gaining diversification even within the US, from Nasdaq to S&P 500 (sector diversification), or from the US to developed markets (geographic diversification) has provided better protection to investors on the downside in almost every correction. 

How are the markets outside the US doing year to date?

The 2025 market landscape is testament to the cyclical nature of investing. While US equities have taken a breather, Europe and China have roared back. To the surprise of many, these generated the highest returns among global markets this year. The darlings of yesteryears such as Japan and India are also struggling. This shift highlights the importance of looking beyond recent performance and the risk of recency bias. The rally in European markets is riding on a recovery narrative in markets like Germany. 

Who would have thought that Elon Musk’s DOGE efforts would derail Tesla’s stock price and that a little-known start-up from China could send shockwaves through Silicon Valley and Wall Street? No one had even heard of DeepSeek before the lunar new year. The subsequent rallies of Chinese tech names caught many by surprise after what seemed like a dismal few years. 

Investors who ignored these regions and zeroed in on only the US tech narrative are missing out. Global economic and political situations, as well as investor sentiment, can change suddenly.

A diversified portfolio is the only effective way to minimise the risk of concentrated bets and prevent missing out on other global opportunities. It is a stark reminder that there is nothing we should take for granted and making forecasts is something we continue to fail at, time and time again. 

2025 year-to-date returns by asset class

Is it time for bonds and other asset classes to shine? 

Bonds have been underperforming for three years now. At the beginning of last year in this very column, I warned again of the complacent bulls in fixed income. Rising interest rates and inflationary pressures are major headwinds that remain. 

However, with signs of US growth slowing, bonds are once again proving their worth as a diversifier. Bonds tend to provide stable income amid volatile equity markets. This inverse correlation is crucial for managing risk and preserving capital. 

With geopolitical uncertainties and potential re-inflation pressures, real assets like infrastructure and real estate can potentially provide a valuable hedge with less correlation with traditional equities and bonds. Commodities outperform in stagflationary environments but should not be a core holding as they don’t compound through cycles like growth equities.

Control what you can control

Investing isn't just about numbers; it's about psychology and behaviour. Fears or greed can drive investors to chase hot trends, drawing concentration and other risks into the portfolio unbeknown to the investor.  

Diversification, on the other hand, is a sure way to reduce risk. It does require discipline and controlling emotions. One must resist the urge to chase short-term gain or follow others blindly. Instead, it is about balancing risk with opportunity, making sure any investment is suitable for your investment objectives. 

This requires building a portfolio that can withstand the test of time. Diversification helps to smooth out the volatility that markets will invariably throw at us and dampen the emotional roller coaster we experience during those times.

We cannot control the markets, the economy or what happens in the future, so we shouldn’t stress about what we cannot control and focus on what we can. The lessons of the past and the most recent market shifts are clear: diversification is not a luxury; it's a necessity. 

Embracing a well-diversified approach to investing, mitigates risk, capitalises on emerging opportunities. In a world that chases after instant gratification, having a long-term perspective and delayed gratification is a superpower when it comes to investing.

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Behind the portfolios is an implementation of a strict, institutional-grade screening process by the Endowus Investment Office with a combined 100+ years of institutional investing experience.

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For an overview of all the funds available through Endowus, refer to our investment funds list or learn more about our other model portfolios in this article.

Read more:

• Introducing Endowus Flagship Portfolios: a core strategy for your financial goals
• Is diversification dead?
• Like Lego play, is your investment portfolio built to last?

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