Diversification: What worked in 2018 and comparing that to what worked in 2008

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No surprises here, when volatility reared its head throughout 2018, the “safety” classes outperformed risk. That should make intuitive sense, especially when considering the S&P500s 18.7% return in 2017 (and 21.4% when including dividends).

But as we all should know, it pays in the longer term to have some diversification. If anything, I prefer to have some asset classes that zig while everything else zaggs. For example, in 2018 the S&P was down ~5% for 2018 when including dividends.

But looked at what happened right when volatility hit (as a reminder, 2018 was not a good year for bonds up until that point… the 10 year treasury yield had moved up to 3.25% in October). Long-term treasury bonds nearly erased their losses and the aggregate bond index eked out a small gain. Purchasing power maintained.

asset class returns

As I shared in my post on Ray Dalio’s All Weather portfolio, I like to see what worked in the last recession as it may provide an indication of what worked then and what will work in the next recession. Obviously, history does not repeat itself, but there is a pattern here: good times – risk stocks outperform. Bad times: people fly to quality. The important thing is being the right sport before everyone else does.

So lets look at what would have preserved purchasing power the best in the last cycle. I want to see what did well in 2008.

  • The blue line is a 60/40 portfolio of stocks and the Barclay’s Agg index (bonds)
  • The red is a selection of assets that performed the best with minimum volatility (more on this below)
  • The yellow line is simply the S&P500

2008 comparison

Surprisingly, this is the breakdown of what constitutes the red line may not be intuitive. It is made up of:

  • 40% S&P500
  • 26% long term treasuries
  • 14% gold
  • 12% MLPs
  • 8% high-yield bonds

The treasuries clearly helped perform then, both from a flight to quality in the Great Recession as well a compression in interest rates. As you can imagine, this would have allowed you to sell some outperforming asset classes (i.e. treasuries) and buy underperforming assets (stocks).

The same is true for 2018. Having some exposure to bonds would have given you the privilege and opportunity to buy stocks!

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