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Is Your Portfolio Diversified Enough?

For many investors, the answer is no. Here’s how to fix it. 

Is Your Portfolio Diversified Enough?

Christine Benz: Another pitfall that I’ve observed in the portfolios that I’ve looked at is just the lack of diversification. We touched on people coming into retirement with too little in safe assets. I would say that’s probably problem number one for many of the portfolios that I look at. But a couple of other issues that I see when I observe portfolios today is too light international exposure, too little in non-U.S. stocks, too much in growth stocks, and a lack of inflation protection. So, we’ll just take these one by one.

U.S. stocks on this slide, you can see how well they've performed, growth stocks especially. The red line depicts the Vanguard Growth Index. You can see it's had a little bit of a fall from grace so far in 2022, but it's dramatically outperformed the Value Index. Its value counterpart has lagged badly over the past—this period is like 18 years now. It's been a long dark night for value stocks. Many investors just tend to let their winners ride, and that has led to overexposure to the growth column of the style box. Of course, we've seen growth stocks get knocked down so far this year, but nonetheless, many portfolios do have overly aggressive allocations to U.S. growth stocks.

Another issue we see is that, because U.S. stocks have outperformed non-U.S. stocks, many portfolios are overweighted in U.S. stocks relative to, say, the global market cap or any professional asset-allocation recommendation. And this is an issue because, by many measures, non-U.S. stocks are inexpensive relative to U.S. stocks today. So, valuations are lower. Dividends are higher. Certainly, there are a lot of macroeconomic headwinds for non-U.S. stocks to be worried about, even more worried perhaps than the U.S. market. But thanks to higher dividends and lower valuations, I think investors should revisit the non-U.S./U.S. allocation in their portfolios.

This is just a look at our style box. You can use our X-Ray tool to evaluate your portfolio's growth versus value exposure. What you're looking for is a somewhat equal distribution. I don't think you have to get too into the weeds in terms of calibrating so that it's a third, a third, a third value, blend, and growth. But you're looking for at least a somewhat equal distribution across those three columns of the style box.

In terms of setting your U.S. versus non-U.S. exposure, the global market capitalization, I think, is a starting point. When we look at that today, U.S. stocks compose about 60% of the value of all of the stocks on the globe and non-U.S. compose about 40%. I think that's a starting point. Younger investors especially can use that as a starting point. When we look at target-date funds, I would say that's another good benchmark when setting non-U.S. versus U.S. exposure. The average 2060 fund, so geared toward young people who are expecting to retire in 2060, you can see that that's 64% U.S., 36% non-U.S.—a little higher U.S. allocation for people who are getting close to retirement. And the key reason is that in retirement you will be spending your funds presumably in U.S. dollars. So, you just want less of the foreign-currency fluctuations that typically accompany non-U.S. stocks in your portfolio. So, you might back off of that global market capitalization a little bit when setting your non-U.S. exposure.

When I look at most U.S. investors' portfolios today, I don't see non-U.S. holdings that are anywhere close to what's depicted on this slide. This is something to take a look at, especially if you want to help set yourself up for potentially better returns over the next decade. You would likely want to emphasize non-U.S. because of better valuations and better dividends there.

Inflation protection is another missing component of many investors' portfolios, or at least it's lacking. So, for long-term inflation protection—and I would tend to take this in two pieces: One is, How do I inflation-protect the long-term component of my portfolio? Well, I do that in a couple of ways. I do that by owning stocks, which over long periods of time have tended to outearn the inflation rate. So, even retirees should have ample equity exposure in their portfolio just to give their portfolio a fighting shot at growing beyond the inflation rate. You might also look at commodities, which I'm a little bit lukewarm on, but we've seen an ability to defend against inflation, at least so far in 2022 and in previous inflationary spikes. Real estate, whether direct real estate ownership or real estate equities, also looks halfway decent from the standpoint of inflation-protection. Those are all categories that I would think about when setting up my long-term portfolio to defend against higher inflation.

For people who are getting close to retirement or in retirement and actively drawing upon their portfolios, I think they want to make sure to add inflation protection to that portion of the portfolio that they'll be drawing upon. There are a couple of key categories that belong in this portion of the portfolio. One would be I Bonds, which are issued directly from the U.S. Treasury. You can buy them from You need to set up an account there, but it's well worth doing because they tend to be the purest form of inflation protection that you can add to protect your purchasing power. Unfortunately, purchase constraints limit you to just $10,000 in annual purchases per taxpayer and then an additional $5,000 through your tax refund, but well worth investigating.

Treasury Inflation-Protected Securities are another category that help protect the purchasing power of your fixed-income portfolio. I've long liked and recommended short-term Treasury Inflation-Protected Securities, in part because they tend to get buffeted around a little less by interest-rate changes, which is what we've had coming on strong in 2022. So, look at Treasury Inflation-Protected Securities, especially short-term. You can buy funds and exchange-traded funds that focus specifically on that area.

When we look at retirement-income funds to help determine, well, what’s the right allocation to TIPS as a component of someone’s fixed-income portfolio. Most of them come in in the realm of around 25% of the fixed-income weighting. You wouldn’t want to hold all of your fixed-income portfolio in TIPS simply because that’s not very diversified. But with a roughly 25%, 20% allocation of the bond portfolio, you do pick up inflation protection and help protect your purchasing power.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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