The S&P 500 (IVV) has made a remarkable recovery in 2023, bouncing back from a challenging year in 2022 when it suffered an -18.16% decline. As of July 2023, the index has surged by an impressive +20.65%, recouping most of its losses from the previous year. However, it is essential to recognize that a balanced investment portfolio relies on diversification to achieve a smoother journey toward financial goals. While the S&P 500 comprises 500 stocks, its performance this year has been predominantly influenced by the outstanding gains from a group of high-performing stocks known as the "Magnificent Seven" (Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla and Meta).
Diversification is a strategy that aims to reduce risk and improve the overall risk/return profile of an investment portfolio. By including assets with lower correlations to each other, the impact of market fluctuations on the portfolio can be mitigated. While the S&P 500 is a prominent option for investing in equities, there are numerous other major equity asset classes and strategies worldwide that offer the potential for good risk/return profiles and diversification.
The performance of various asset classes in July 2023 exemplifies the value of diversification. Per the table below, in contrast to the core S&P 500 index several other diversifying equity asset classes, including small-cap (SCHA), mid-cap (SCHM), and emerging markets (SCHE), outperformed, delivering higher returns. This demonstrates that diversification can yield positive results even when the primary market index lags.
While some diversifying equity asset classes performed well in July, they still trail the S&P 500 on a year-to-date basis by substantial margins. This underscores the importance of long-term perspective and the understanding that different asset classes may perform differently over extended periods.
Also, and perhaps even more interesting, is the benefit of diversification in the fixed income space! Per the bottom half of that table, please note that ALL diversifying fixed income asset classes have OUTPERFORMED core bonds in July and on a year-to-date basis! The Bloomberg Aggregate Bond index (SCHZ) was down -0.15% in July and up +2.26% YTD lagging the other major fixed income areas. This further demonstrates that diversification can be beneficial, even in fixed income investments.
While the S&P 500 has shown impressive recovery in 2023, it should not be the sole focus of investment. Including other major equity asset classes and strategies globally, as well as diversifying within the fixed income space, can provide a more stable and potentially rewarding risk/return profile. Investors should carefully consider their financial goals and risk tolerance when constructing a diversified portfolio to achieve long-term success.