The state of the fixed-income market can also potentially impact portfolio performance. Bond prices commonly fall when interest rates rise, which presents a short-term concern for an investor. If a bond is held to maturity, though, the investor will receive the promised principal and interest (assuming no default on the part of the issuer). Moreover, a rising interest rate environment may help the fixed-income segment of the portfolio’s long-term performance. New bonds issued in a rising interest rate environment have the potential to generate more yield than the older bonds of similar duration that they replace.
This year, U.S. stocks have done well. A portfolio 100 percent invested in the U.S. stock market in 2019 could have expected a year-to-date return approximating that of the S&P 500. But how many strategies invest entirely in US Stocks, without exposure to international and emerging markets?
Assume there actually is a hypothetical investor this year who is 100 percent invested in equities, as follows: 50 percent domestic, 35 percent developed foreign markets and 15 percent emerging markets. In this illustration, the S&P 500 will serve as the model for the U.S. market, MSCI’s EAFE index will stand in for developed foreign markets, and MSCI’s Emerging Markets index will represent the emerging markets. Through July, the S&P was +18.89 percent year-to-date, the EAFE +10.31 percent YTD, and the Emerging Markets just +7.38 percent YTD. As foreign and domestic stocks have equal weight in this hypothetical portfolio, it is easy to see that its overall YTD gain would have been less than 18.9 percent as of the July 31 closing bell.
Your portfolio is not the market – and vice versa. Your investments may return less than the S&P 500 (or another benchmark) in a particular year due to various factors, including the behavior of the investment markets. Those markets are ever-changing. In some years, you may get a double-digit return. In other years, your return may be much smaller.
When your portfolio is diversified across asset classes, the highs may not be so high – but the lows may not be so low, either. If things turn volatile, diversification may help insulate you from some of the ups and downs that come with investing.