Diversification Raises Returns, Lowers Risk -- Here's Proof

My last three columns (from Dec. 21 , Jan. 17 and Feb. 1 ) have focused on analyzing stock market sectors. Many readers -- particularly those who were burned last year by an overexposure to technology -- wrote to say they had never considered sector exposures in assessing portfolios risk.

So I thought a good way to end this series would be a demonstration of how, over time and through bull and bear markets, a sector-diversified portfolio earns higher returns with lower risk (the Holy Grail of portfolio management) than a nondiversified portfolio.

I put together a demonstration focusing on technology, health care and financial services -- sectors I believe will continue to grow faster than the S&P 500 index. You could, for example, put all your money into a technology fund, knowing that over time this fund will substantially outperform the S&P 500. But as James Cramer noted a few weeks back, you can get really punished in an off year. What happens to a portfolio where you initially allocate one-third of your assets to each of these three sectors and rebalance back to those one-third allocations every January?

Choosing the Right Data

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