Diversification is the key to eliminating asset-specific risk from a portfolio. As this article points out, a diversified portfolio will never have the highest return in any particular short-term period. In fact, on average, a diversified portfolio should have middle of the road performance over a short period such as a month. However, as the results of this article show, over the long-term, a diversified portfolio can actually outperform many of the individual assets in the portfolio without the increased level of risk. In this case, from September 2003 to May 2013, a $10,000 investment would have grown to $19,860 if it were invested in the S&P 500. Over the same period, the investment would have grown to $24,199 in a diversified portfolio.
We should note a couple of caveats. First, the hypothetical portfolio in this example was rebalanced monthly. In other words, whatever the beginning portfolio weight at the beginning of each month, the portfolio was readjusted at the end of the month so that the original portfolio weights were restored. While rebalancing is important, a longer rebalancing period, say a year, is probably preferable. Second, while we strongly believe in diversification (And our own portfolios prove it!), the portfolio chosen by the author is aggressive and is not suitable for all investors.
