This is probably too technical a read (hat tip to CB Insights) for your high school students but might help all of you who hold a diversified portfolio of index funds (or mutual funds for that matter). Three of my larger stock ETF holdings today (Vanguard ETF tickers in parentheses)  are the S&P500 (VOO), International stocks (VXUS) and Emerging Markets stocks (VWO).  The challenge as an investor in holding a portfolio like this is that you are constantly gauging the performance of the ETFs and wondering why you are holding the two ETFs that are underperforming (yes, when you hold three assets like this,  you will always have one asset that outperforms the other two).

As the data below demonstrates, I would have been better off putting all my eggs in one basket (S&P500) as the other two asset classes (International Stock and Emerging Markets) have significantly underperformed.

Here’s the data comparing the performance of the ETFs over the YTD, 1-year, 3-year and 5-year periods (I feel even worse now!):

I mean, look at the five year records with Emerging Markets underperforming the S&P500 by almost 16% PER YEAR (-4.19% for EM vs. 11.53% for S&P500). International is a little better at underperforming the S&P500 by ONLY 11% PER YEAR (0.57% vs. 11.53%). Well, the good news is that I was much more heavily weighted toward the S&P500 (over 70% of my portfolio) but still why didn’t I put 100% of my stock portfolio in the S&P500?

Here is where the blogger hits just the right tone on why I should avoid that temptation:

Viewed with the benefit of hindsight, diversification will always disappoint.  To judge the outcome of diversification after the fog of uncertainty has lifted, however, misses the point: diversification provides us the incredibly important ability to admit we don’t know.  We can be vaguely right instead of precisely wrong.  Constant disappointment, then, might be the greatest indicator that we are well diversified.

So, yes, diversification will always disappoint but don’t let hindsight bias actually make you believe that you could have predicted this five years ago. Granted, it’s a short time frame but guess what asset class performed the best through March 31st of this year? Emerging Markets with a 6% return vs. 1.36% for the S&P500. Maybe it will be their time to shine now…or not! Prepare to always be disappointed with a diversified portfolio.

About the Author

Tim Ranzetta

Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.

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