Why ignoring diversification could cost you in the future
A diversified portfolio is the only effective way to minimise the risk of concentrated bets and to ensure participation in global opportunities
THE US market and, in particular, technology shares are down from their peak this year at minus 12 per cent for Nasdaq, minus 8 per cent for S&P 500, and minus 6 per cent for the MSCI World Developed Market Index.
Do you see a pattern? The broader the index, the less it has fallen. Europe and Hong Kong/China markets are not only positive, but also up by double digits.
The major US equity indices have posted double-digit gains for two consecutive years, which made people complacent. The Nasdaq had only one correction of more than 10 per cent in 2024 and two in 2023, while the S&P 500 did not see a single correction of 10 per cent throughout 2024 and had only one in 2023.
Such a period of sustained, stable and concentrated gains drew many into building US-centric or even US-only portfolios. Talk of US exceptionalism reached fever pitch this year. Such peak sentiment should always raise some scepticism. A strategy may seem bulletproof when markets are in your favour. Some may believe diversification is dead, and ask: “Why spread your bets, when a strategy delivers such remarkable returns?”
Recent market volatility explains why one needs to diversify, and it also serves as a stark reminder of a fundamental truth. Diversification is not just a prudent strategy, it is also a friend in the unpredictable world of investing. It helps us manage our volatile emotions and guide us in the right behaviour to increase our chances of survival and success in markets.
The dangers of concentration
We know how we got here. Heavy investments into and rapid adoption of artificial intelligence (AI) have driven an insatiable appetite for chips, computing power and the stocks of companies behind them. Investor fervour for the Magnificent Seven has reached new heights on optimism that AI will drive massive productivity gains that will justify everything, including the high valuations.
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Magnificent Seven is a group of influential companies in the US, which includes Alphabet, Amazon, Apple and Meta.
While backed by strong growth, it is worth reminding ourselves that the markets move on the second derivative of growth – the delta – not the absolute amount of growth; whether they are accelerating or decelerating in pace; and whether growth is better than expected. We have to assume that all known information, including our own expectations and market forecasts, are priced into current markets.
With stubbornly high inflation and borrowing rates, growth needs to clear a higher hurdle to compensate for higher costs and few companies can achieve it. Most companies that have delivered on growth are in the tech sector and in the United States.
However, we know by looking at the history of financial markets that relying on a single sector, country or region exposes one’s portfolio to significant concentration risks, especially when that sector or region becomes crowded and expensive.
A few months ago, earnings revision for the Magnificent Seven stopped moving higher. In other words, the delta on the growth or second derivative stopped moving in our favour, and the stocks have become more vulnerable to a pullback.
Most large US tech leaders do have strong businesses and technology moats. Solid balance sheets and abundant cash flow enable them to sustain their dominance. It is possible that they remain a core long-term holding with a meaningful share of a portfolio. However, putting all our eggs in one basket and failing to take advantage of the opportunities to diversify often hurt us at critical moments.
Diversification cushions impact of market falls
Diversification entails exposure to other sectors, regions and asset classes to minimise the volatility of outcomes or to enhance long-term risk-adjusted returns. Many investors focus on the upside, but one should also be cognisant of the potential risks. Managing risk, especially in downturns, is a critical way to preserve capital and allow long-term compounding of returns.
Looking at all the corrections since March 2020 suggests that gaining sector diversification within the US or a broad exposure to developed markets has provided better protection on the downside in almost every correction.
Markets outside the US
The 2025 market landscape is a testament to the cyclical nature of investing.
While US equities have taken a breather, Europe and China have roared back, generating the highest returns among global markets this year; Japan and India, the darlings of yesteryears, are struggling. This shift highlights the risk of recency bias or the need to look beyond recent performance.
Currently, European markets are riding on a recovery narrative in markets such as Germany.
Elon Musk’s Department of Government Efficiency efforts are derailing Tesla’s stock price; Deepseek, until now, a little-known startup from China, sent shockwaves through Silicon Valley and Wall Street. The subsequent rally among Chinese tech names caught many by surprise after a dismal few years.
Investors who zeroed in on only the US tech narrative are missing out. Global economic and political situations, as well as investor sentiment, can change suddenly. A diversified portfolio is the only effective way to minimise the risk of concentrated bets and to ensure participation in global opportunities. The developments are a stark reminder that nothing is to be taken for granted and forecasts are bound to fail.
Time for bonds and other asset classes?
Bonds have underperformed for three years now. At the beginning of 2024. I warned in this column of the complacent bulls in fixed income. Rising interest rates and inflationary pressures remain major headwinds. However, with signs of US growth slowing, they are once again proving their worth as a diversifier. Bonds provide stable income amid volatile equity markets. This inverse correlation is crucial for managing risk and preserving capital.
With geopolitical uncertainties and the potential recurrence of inflation, real assets such as infrastructure and real estate can potentially provide a valuable hedge, at lower correlation with traditional equities and bonds.
Commodities outperform in stagflationary environments, but should not be a core holding as they do not compound through cycles like growth equities.
Control what you can control
Investing is not just about numbers; it is also about psychology and behaviour. Fear and greed can drive investors to chase hot trends, drawing concentration and other risks into the portfolio.
Diversification, however, is a sure way to reduce risk. It does require discipline and emotional control. One must resist the urge to chase short-term gains or follow others blindly and, instead, balance risk with opportunity, making sure any investment is suitable for one’s objectives. This requires a portfolio that can withstand the test of time.
Diversification helps to smoothen out the volatility that markets will invariably throw at us and dampen the emotional roller coaster we experience during those times.
We cannot control the markets, the economy or what happens in the future; we should not stress about what we cannot control and focus instead on what we can.
The lessons of the past and the most recent market shifts are clear: Diversification is not a luxury; it’s a necessity.
Embracing a well-diversified approach to investing mitigates risk and capitalises on emerging opportunities. In a world that seeks instant gratification, taking a long-term perspective and delaying gratification are superpowers in investing.
Samuel Rhee is co-founder and chairman and Hugh Chung is chief investment officer at Endowus, a digital wealth platform with over S$10 billion in client assets across public, private markets and pension (CPF and SRS)
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