Diversification Beyond Indexing
The internet is a great place to find financial insights, and I love using X (formerly Twitter) to follow portfolio managers, macroeconomists, and advisors I respect. However, the algorithm also brings a lot of bad advice to my feed. Lately, I’ve seen a repetitive trope: “Buy VOO and chill” as the only retirement plan you need. For those not memorizing investment tickers, VOO is the Vanguard S&P 500 Index. I like VOO—it’s one of the cheapest ways to buy into one of the most important indices in the world. But, this raises, is it really a complete retirement plan? There are a few issues with this, but let’s focus on two: recency bias and liquidity.
Recency Bias
Recency bias can distort our thinking. Consider the S&P 500’s performance from 2000 to 2010. During that decade, the annualized return was a disappointing -0.95%.
Yes, that’s right—an entire decade of stagnation. It’s easy to get caught up in the success of the last 15 years, where the S&P has outperformed many other indices, but markets tend to revert to the mean over time. Betting everything on the S&P 500’s recent performance ignores the possibility of future underperformance. I do think VOO can be a significant part of a portfolio, but it shouldn’t be the entire portfolio. True diversification means including mid-cap, international, emerging market funds, and more to ensure exposure to the broader global market. This type of allocation helps manage risk and increases the chances of long-term growth.
Market Risk & Liquidity
Another major issue with an all-equity index, like VOO, is the lack of liquidity and protection during market downturns. If your portfolio only holds stocks and the market drops, you could be forced to sell assets at depressed prices, locking in losses. Bonds, on the other hand, can serve as a ballast, traditionally rising in value when stocks fall—though not always. Without a cash or bond allocation, you expose yourself to the risk of having to sell in a downturn. Liquidity matters, especially in retirement, when you need to ensure you have funds available without selling your growth assets at the wrong time. A well-balanced portfolio not only diversifies across stocks but also incorporates cash or bonds to help manage liquidity needs and market risk.
In summary, while VOO and other indices are a solid investment, it’s not a retirement plan in itself. Real diversification involves spreading your investments across different asset classes and ensuring you have the liquidity to handle market fluctuations. Remember, all things tend to revert to the mean—what’s been the best performer recently may not always be, and preparing for that is key to long-term success.
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