Diversifying Using Asset Classes

Source: Morningstar Direct, 1/1/2009 - 12/31/2018. 10-year annualized return. Vertical placement shows return – the higher the asset class, the higher the return. Horizontal placement shows risk – the farther to the right, the higher the asset class risk. Cash represented by the Barclays U.S. Treasury Bellwethers 3Mon Index. U.S. investment-grade bonds represented by the Barclays U.S. Aggregate Bond Index. High-yield bonds represented by the Barclays U.S. HY 2% Issuer Cap Index. International bonds represented by the Barclays Global Aggregate Ex U.S. Index. U.S. large-cap stocks represented by the S&P 500 Index. REITs represented by the FTSE NAREIT All Equity REITs Index. Developed international large-cap stocks represented by the MSCI EAFE NR Index. U.S. mid-cap stocks represented by the Russell Mid Cap Index. U.S. small-cap stocks represented by the Russell 2000 Index. International small- and mid-cap stocks represented by the MSCI EAFE Small-cap Index. Emerging-market stocks represented by the MSCI EM Index. Commodities represented by the S&P GSCI Index. Past performance does not guarantee future results. An index is unmanaged and is not available for direct investment.

Better-diversified portfolios that include all of our recommended asset classes have had better risk-adjusted performance over time.* But as the chart shows, asset classes don’t perform identically. That’s why it’s so important to construct and rebalance your portfolio using appropriate proportions as well as your comfort with risk, time horizon and long-term goals.

Higher returns mainly reflect higher risk – In general, riskier asset classes – including all of the equity investments – had higher average returns than fixed-income investments, showing that risk and return go hand in hand. High-yield bonds were an exception, but they also provide less portfolio diversification because they frequently move with equities. Domestically, riskier small- and mid-cap stocks had higher returns. And internationally, riskier emerging-market stocks and small- and mid-cap stocks outperformed international developed large-cap stocks.

Over the past 10 years, commodities had above-average volatility and negative returns. Historically, commodities have performed well when other asset classes declined, which is not our outlook. And as a group, international investments had lower returns than similarly risky domestic investments, as the rest of the world rebounded more slowly from the global financial crisis and the U.S. dollar rose 1.8% annually.

Realistic expectations – The historical performance of each asset class provides some insight for constructing your portfolio, but it’s not enough. Returns over the past 10 years were generally higher than what we expect over the next 10 years based on current valuations and conditions.* Constructing and maintaining a well-diversified portfolio also requires understanding correlations (how much asset classes move together), as well as other considerations. Your financial advisor can partner with you using sophisticated tools to help select and adjust your portfolio appropriately over time.

Action for investors

As you review your portfolio, you may need to reduce asset classes that have outperformed and add to those that have underperformed. Don’t avoid international equity investments or others that have lagged – they’ve frequently outperformed following past times of below-average performance. But if you own commodities, we recommend limiting them to a small allocation in your portfolio.

Important Information:

*Past performance is not a guarantee of how the markets will perform in the future.

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