Does Diversification Still Work?

When looking at the performance of their portfolios, many investors can’t help but wonder “If only” – “If only I had greater exposure to that big winner” or “If only I’d had less of my portfolio in that laggard.” With this mindset, you may be tempted to think the only thing diversification accomplishes is offsetting your best investments with your worst ones – guaranteeing mediocrity. Investing, though, is about looking ahead and making thoughtful decisions in the face of an unknowable future. From that perspective, diversification is often a critical tool for building a robust portfolio in an unpredictable market.

What is Diversification?

Diversification is a basic portfolio strategy whereby you invest in a mix of uncorrelated asset classes – so when some investments zig, others will zag. Instead of putting all your investment eggs into one basket and hoping for the best, you’re distributing them across several independent baskets. Because uncorrelated investments' returns are driven by differing underlying forces, the impact of poor returns in one asset class can be offset by strong returns in another part of the portfolio. This process can help boost risk-adjusted returns and smooth out the investor’s ride.

Do You Feel Lucky?

Markets are volatile and cyclical – picking the best performing asset class year after year is functionally impossible, and going one step further, one year’s winners are often the next year’s big losers (e.g., Commodities were the best performing asset class in 2005 and the worst in 2006; Large Cap Growth was a big outperformer in 2020-21 post-pandemic, only to fall to the bottom of the table in 2022). Instead of trying to predict which investments will perform the best – and getting the timing just right to capitalize on it – a diversified portfolio can make it easier to participate in broad market gains and produce more stable returns.

Protection When Markets Go South

Diversification can be especially powerful in a bear market, like the one we saw in 2022. While a diversified portfolio may still suffer losses, those losses tend to be far less severe when compared to an undiversified one. This is a powerful tool for investors – not only because the drawdown is less severe (thereby allowing for a faster recovery when things improve), but also because it limits the natural human inclination to sell during times of stress. Diversification helps investors avoid making those sort of knee-jerk reactions that are crippling to long-term wealth-building. In down markets, diversification also allows investors to benefit from strategies such as rebalancing (buying low / selling high) and tax-loss harvesting.

Focus On The Big Picture

It is incredibly difficult to predict what sector or asset class will shine the brightest in a given year. And while a diversified portfolio will always own whichever area of the market that ends up being, it will also own its share of laggards. In fact, there is likely no point during the cycle where being diversified will feel good – it will always feel like the portfolio is missing opportunities. Diversification is often boring and usually uncomfortable, but over longer periods of time, it is a strategy that greatly benefits investors who stay the course.

Like any investment strategy, though, diversification isn’t foolproof. All investments carry the risk of loss and diversification does not guarantee a profit. Before making any investment decisions, you should carefully consider what you’re investing for – the future you’re envisioning for yourself and your family – and the best way to achieve those specific goals. Your Baird Financial Advisor has access to a variety of resources, including tax-smart indexing solutions, and expertise in both financial planning and investment management to help you create a wealth management solution that’s right for you.

This article was originally published in April 2019 and updated in July 2025.

The information offered is provided to you for informational purposes only. Robert W. Baird & Co. Incorporated is not a legal or tax services provider and you are strongly encouraged to seek the advice of the appropriate professional advisors before taking any action. The information reflected on this page are Baird expert opinions today and are subject to change. The information provided here has not taken into consideration the investment goals or needs of any specific investor and investors should not make any investment decisions based solely on this information. Past performance is not a guarantee of future results. All investments have some level of risk, and investors have different time horizons, goals and risk tolerances, so speak to your Baird Financial Advisor before taking action.