This article was published on 4 October 2005. Some information may be out of date.

A message that goes too far — Shares beat mixtures over long term

I take exception to a recent New York Times article entitled, “The long-term lesson: It pays to diversify”. If you look hard at the numbers quoted by the writer, they show just the opposite.

By “diversification” the writer doesn’t mean owning a wide variety of shares or bonds or properties, but spreading your money over the different types of assets.

Such a strategy certainly seems to work in the short term.

Over the three years ending last December 31, someone who invested only in US shares would have made an annual average return of only 3.6 per cent, the article says.

If, instead, they had invested 55 per cent of their money in shares, 30 per cent in bonds, 10 per cent in commodities (oil, gold and so on), and 5 per cent in cash, their average return would have been almost double that, at 7 per cent.

Over the five years through 2004, the difference is even starker. In shares alone, the average return was minus 2.3 per cent a year. In the mixed portfolio it was 3.4 per cent.

While shares performed abysmally, the other types of investments grew strongly.

“The lesson is that stumbles and recoveries are inevitable, and that means diversification is a very good idea,” says the writer. “It increases the chance that something in your portfolio is going up when other portions are going down.”

So far so good. While the numbers paint shares in a bad light — in fact, more often than not they perform better than the alternatives — there are certainly many periods in which they do worse. If you’re investing for the short term, beware of share volatility.

But then the writer looks at longer periods.

Over ten years through 2004, the return on the mixed portfolio averaged 11 per cent; on shares alone it averaged 12 per cent. And over 15 years the mixed number was 10 per cent versus 11 per cent on shares.

“Over a longer period, a stock-only portfolio fared better, but not by much,” says the writer.

That’s misleading. The small difference is only because, at 55 per cent of the mixed portfolio, shares dominated.

Let’s look at each type of asset separately.

The 15-year average annual return on bonds was less than 8 per cent — well below 11 per cent on shares. On commodities it was 7 per cent, and on cash just 4 per cent.

And over long periods, those differences really add up. If you started with $10,000:

  • In shares that would have grown to $47,200 over 15 years.
  • In bonds it would be $30,400 — less than two-thirds of the share total.
  • In commodities, you would have $28,000.
  • In cash, you would have $19,100 — much less than half the share total.

A portfolio with more bonds, commodities and cash and less shares would have lagged well behind an investment in shares alone.

I’m not criticising the message that spreading your investments widely reduces volatility. That’s undisputed.

If you can’t cope with short-term volatility — if, for instance, you would have bailed out of shares when their value was falling — you are better off investing elsewhere as well.

If, however, you have the stomach to stick with shares through their ups and downs, and you are investing for, say, 15 or more years, you will almost certainly end up with more if you invest only in diversified shares.

And that’s not based just on research over one period in one country. It’s a consistent message.

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Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it.