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I wanted to ask a follow up questions to the questions linked below.

Why would I want a diversified portfolio, versus throwing my investments into an index fund?

I have a personal financial adviser who follows the diversified portfolio theory, and I've read the explanations in that answer as well as heard of the advantages of a diversified portfolio. However, has anyone put together data that a diversified portfolio of some sort has actually outperformed the S&P 500? I've seen the Blackrock Asset Class returns chart many times and I can see you end up with more stability with the diversified portfolio, but I've never seen anyone cite anything that says such a diversified portfolio actually outperforms the S&P 500 over any time period.

I realize measuring performance can be tricky, as it may depend on which years you choose, or the dates you start your year, but nonetheless, my sense is the diversified portfolio argument is cited as something that's theoretically great, but no one has put together solid data over a long period to show it's better.

EDIT: people have asked for clarification of diversity. By diversity, I mean a portfolio that has holdings from most/all of the assets classes shown in the linked Blackrock chart. I've run into a number of financial advisers who essentially advocate holding as many of those asset classes since you don't know which class will be the best performer.

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  • Note that the answer to the original question isn't either/or. I have a diversified portfolio of index funds.
    – keshlam
    May 15, 2014 at 21:11
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    Over 2008 the S&P 500 had a performance of about -40%. A portfolio of half cash, half S&P 500 would have outperformed this. Tada, there's your data.
    – AakashM
    Jul 31, 2014 at 11:28
  • Its also worth pointing out that index funds are always outperformed by their index (they charge fees that overtime cut into growth) so it is worth comparing the fees associated with buying into and index or a diversified set of stocks
    – sdrawkcabdear
    Sep 20, 2016 at 21:20

4 Answers 4

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Is it POSSIBLE? Of course. I don't even need to do any research to prove that. Just some mathematical reasoning:

Take the S&P 500. Find the performance of each stock in that list over whatever time period you want to use for your experiment. Now select some number of the best-performing stocks from the list -- any number less than 500. By definition, the X best must be better than or equal to the average. Assuming all the stocks on the S&P did not have EXACTLY the same performance, these 10 must be better than average. You now have a diversified portfolio that performed better than the S&P 500 index fund.

Of course as they always say in a prospectus, past performance is not a guarantee of future performance.

It's certainly possible to do. The question is, if YOU selected the stocks making up a diversified portfolio, would your selections do better than an index fund?

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    I think it's implied that by "diversified portfolio", the OP means something with greater diversification than S&P 500.
    – Daniel Lubarov
    May 16, 2014 at 5:44
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    @daniel Hmm, I'd think the S&P 500 is a pretty "diverse" collection. Is there a formal definition somewhere of "diverse portfolio"? I've always understood it to simply mean a collection of stocks, bonds, maybe derivatives, whatever, in companies from a variety of industries and of a variety of capitalization sizes. I'd have to study a list of what's on the S&P 500 but I'm sure it's a variety of industries. I guess it's mostly large cap. But still, okay, if the question is, could you find SOME collection of 10 or 20 stocks, including some not on the S&P 500, that beat the S&P 500 average ...
    – Jay
    May 16, 2014 at 13:21
  • ... in a specified time period? Yes, you'd have to do some research to prove that such a collection exists. But I'd be greatly surprised if you could not find SOME set of stocks that beat the S&P 500, if the 20 (say) best performing stocks in the world did not do better than the S&P 500. The S&P 500 is deliberately designed to be representative of the economy as a whole, not to be a collection of the best performers.
    – Jay
    May 16, 2014 at 13:31
  • I guess the OP's question wasn't that clear, but I think this is what he was getting at: say you divide your funds (and regularly rebalance) between S&P 500, a small cap fund, a foreign stock fund, an REIT fund, and so forth. Could such a portfolio outperform all of the underlying asset classes? It is sometimes claimed (e.g. by Wealthfront) that rebalancing not only decreases risk but also increases expected gains; I think the OP was looking for evidence to support or repudiate these claims.
    – Daniel Lubarov
    May 16, 2014 at 17:43
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    @Daniel - or rebalancing can be seen as selling your winners and buying more of your losers.
    – Victor
    May 16, 2014 at 21:24
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Stocks, Bonds, Bills, and Lottery Tickets notes the work of Fama and French who researched the idea of a small-cap premium along with a value premium that may be useful to note in terms of what has outperformed if one looks from 1926 to present.

Slice and dice would also be another article about an approach that over weights the small-cap and value sides of things if you want another resource here.

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While it's definitely possible (and likely?) that a diversified portfolio generates higher returns than the S&P 500, that's not the main reason why you diversify. Diversification reduces risk.

Modern portfolio theory suggests that you should maximize return while reducing risk, instead of blindly chasing the highest returns. Think about it this way--say the average return is 11% for large cap US stocks (the S&P 500), and it's 10% for a diversified portfolio (say, 6-8 asset classes). The large cap only portfolio has a 10% chance of losing 30% in a given year, while the diversified portfolio has a 1% chance of losing 30% in a year. For the vast majority of investors, it's worth the 1% annual gap in expected return to greatly reduce their risk exposure.

Of course, I just made those numbers up. Read what finance professors have written for the "data and proof". But modern portfolio theory is believed by a lot of investors and other finance experts. There are a ton of studies (and therefore data) on MPT--including many that contradict it.

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Yes, a diversified portfolio can generate greater returns than the S&P 500 by going OUTSIDE it.

For instance, small stocks (on average) generate higher returns than the "large caps" found in the S&P 500. So if you own a diversified portfolio of stocks, some of which are smaller (in market cap) than the typical S&P 500 stock, you have a chance to outperform.

You might also outperform by owning other asset classes than stocks such as gold, real estate, and timber (among others) at appropriate times. (You may also be able to get the relevant exposure by owning gold and timber stocks and REITS.) This was a lesson that David Swensen of the Yale endowment taught us.

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