The why, what and how of putting your eggs in different baskets during volatile times
It’s barely half over, but it seems pretty clear that 2025 will go down in the history books as a year of change.
Long-standing national relationships seem very much up in the air. Existing alliances have been called into question. Old friendships have become strained. Conflict over trade, tariffs and tweets has led to ongoing political friction and a good deal of market mayhem. It seems that we have entered a new age of uncertainty in which investment markets and entire economies can change every time you turn on the nightly news – or scroll through your social media feed.
If there’s one overarching lesson that investors can take from 2025, it’s the importance of diversification. Just as Canada has learned a difficult lesson in how over-reliance on a single economic partner can leave you exposed to shifts in policy or politics, so too have investors learned how overweighting a single asset class (stocks), one geographic market (U.S. stocks) or one investment strategy or approach (U.S. growth stocks) can leave you dangerously vulnerable to the downward pressures that occur when trade policy or tax regulations or geopolitics change on a dime.
All of which makes this an exceptionally good time to take a deep dive into diversification and examine closely what the strategy entails, its purpose and how you might put it to work to make your portfolio a little stronger (and your sleep a little sounder) in this time of rapid economic and market change.
The basics of diversification
Investment diversification is a portfolio strategy that even the most novice investor or casual market-watchers can understand. At its most basic level, diversification is simply the financial articulation of that wisdom which we’ve all heard at one time or another: don’t put all your eggs in one basket.
It’s common sense, really – because not every investment moves in the same direction at the same time, it makes sense to spread your investments across a mix of asset classes, geographies and investment approaches. By owning a combination of different investments, the losses that you might experience in one investment might be offset (at least to some degree) by the gains which you realize in another. Over time, this strategy leads to more stable, more predictable returns which, in turn, lead to less sleep lost due to market volatility and more strategic, less emotional decision-making.
The classic example of investment diversification is the so-called 60/40 portfolio split between stocks and bonds that you’ve probably heard about. Speaking very generally, stocks offer potential for growth while bonds provide stable, predictable income. Because stocks generally fall during economic slowdowns while bonds often rise (or at least hold their own), combining these two in your portfolio should theoretically help to smooth out the wild ups and downs which your portfolio would experience if you simply went all-in on either one.
Over the years, a number of academic studies have been done to suggest that the optimal combination in most market environments is a portfolio comprised of somewhere in the neighbourhood of 60% conservative blue-chip stocks and 40% government bonds. Keep in mind, however, that “optimal” does not mean “risk-free.” Yes, diversification can minimize the impact of poor performance in any one asset class or market geography. But it’s by no means a panacea or perfect antidote for market risk. Even the most well-diversified portfolios will experience sudden drops and drawdowns in the face of market turmoil.
Why diversification matters
It doesn’t take a PhD in finance to see the benefits of such an approach. By combining multiple investment types in your portfolio, you’re not betting big on a single investment or market outcome – you’re preparing for many, thereby minimizing the overall volatility in your portfolio. When one part zigs, the other part zags, helping you focus on your long-term financial goals instead of short-term market swings. That can help you avoid the emotional overreactions which can sometimes result when your portfolio shows a big swing in either direction.
The following chart is a good visualization of why diversification matters. The chart tracks the performance of a selection of common asset and geographic allocations since 2010, as measured by the performance of several mutual funds and ETFs that track an index associated with the asset in question. Keep in mind that, because of the management fees, transaction costs and other expenses incurred by such funds, these numbers aren’t an exact replica of the performance of the underlying asset. But they’re pretty darn close.
Annualized returns, selected assets 2010-2024
(Adjusted for inflation and reinvestment of dividends) 
Sources: Chart design and concept: Jay Kloepfer and The Measure of a Plan. Chart data: Yahoo Finance, Vanguard, iShares, Libra Investment Management, Bogleheads forum.
One thing that should jump out immediately is how varied the chart is: the performance of the various asset classes is literally all over the place, with several instances of the “winning” asset in one year falling down to the bottom of the pile the very next year. That’s a pretty good rationale for the reason we need assets that zig when others zag – because sooner or later, every asset does just that.
The other major point which the chart makes obvious is how much performance in any one year can diverge from the long-term average. Just to pick one example – U.S. large cap stocks have put in a dominant performance over the past 15 years, with an average return of 8.6%. But that number doesn’t really do justice to the impact (either financial or emotional) which investors experienced with a -23.6% return in 2022.
For retirees (and the soon-to-be-retired), this is why a diversified portfolio is almost always a smart idea. Once you’re retired, your financial goals shift from maximizing wealth to protecting what you already have, and maintaining a stable, steady source of income throughout your golden years. Diversification can play a key role here, smoothing out some of the dramatic swings which you see in the asset return chart, and eliminating some of the stress that you’d experience if you saw the bulk of your portfolio drop by a whopping 24% in a single calendar year.
Types of diversification
Investors can diversify a portfolio along several different avenues in order to reduce risk and improve long-term stability. Here are some of the most common, along with a brief description of some of the forms that diversification can take within each avenue.
Asset class diversification
Perhaps the most well-known way to diversify is between different assets. Each asset type performs differently in different market conditions, and can play a different role in balancing overall portfolio volatility and generating income throughout retirement.
Some of the more common asset classes include:
Equities – Equities (or stocks) is the name for direct ownership stakes in operating businesses. While there are many different types, spanning all kinds of industries and sectors, generally speaking, stocks often offer more potential for growth than do many other asset types – an essential quality for retirees who want their portfolios to keep up with the rising cost of living during retirement.
Fixed income – Bonds, guaranteed investment certificates (GICs) and similar investments all offer predictable interest income along with lower volatility than stocks typically do. While there’s a wide spectrum of volatility and return within the broader category (government bonds generally experience much lower volatility than corporate bonds, for example), as an asset class, they offer greater stability than stocks. That makes them an attractive option for conservative retirees.
Real assets – A broad label that describes tangible, physical assets: real estate, infrastructure such as airports and toll roads, and commodities such as oil, industrial metals and agricultural products. Historically, holding such assets (or investing in funds, ETFs or listed companies which invest in them) has offered an excellent degree of diversification from stocks and bonds, particularly during times of inflation.
Cash – Cash and other short-term investments (money market funds, certificates of deposit and so on) aren’t just for emergencies or present-day spending needs – these can also act as a ballast for other portions of your portfolio when the economic seas get rough, and can protect you from having to sell other investments at an inopportune time.
Alternative investments – Hedge funds, private equity or credit, and venture capital have historically been the territory of large institutions, endowments and high-net-worth investors, but they’ve become increasingly popular among “average” investors in recent years. Their performance is often quite uncorrelated to public securities, but their complexity and liquidity restrictions make them best suited for sophisticated, experienced investors.
Precious metals – Historically, gold (and, to a lesser extent, silver and platinum) has offered investors a safe haven in times of high inflation, as its value generally increases when the relative value of currency (particularly the U.S. dollar) drops. It also tends to have a low correlation with the performance of other assets, which can help to reduce overall portfolio volatility during times of political and economic turmoil.
Market cap diversification
For equity investors, another level of diversification is by market capitalization: how large a company is, as measured by its total market value. Market cap functions as a general measure of where a company is in its development cycle, and gives you a very rough idea of its financial stability. While the distinction between one level and the next can differ, the following are generally agreed upon:
Large cap – stocks with a market capitalization of more than $10 billion. Typically, well-established businesses with substantial operating history but, occasionally, they can be hyped-up businesses with big growth prospects (pretty common in the technology sector, for example). Speaking generally, large cap companies have a greater ability to absorb the ups and downs of the economic cycle – a feature that makes them more attractive to conservative investors.
Mid cap – companies between $2 billion and $10 billion with higher growth prospects than large-cap companies, but with better financial resources than many small-cap stocks. Mid-caps have historically been somewhat overlooked compared to large caps and small caps, but many can offer an attractive combination of financial resilience and future potential growth, as they make the transition into large cap companies.
Small cap – companies between $250 million and $2 billion in value. Many companies in this range have far greater growth potential than larger competitors, but keep in mind that their smaller size often leads them to be much more volatile. Historically, small caps don’t always move in tandem with large companies, providing a level of diversification for the overall portfolio.
Micro cap – companies below $250 million in market capitalization. Typically, startups, high-tech innovators and (particularly in Canada) companies in the business of mineral or energy exploration. This is the world of big risk/big reward. Because a good portion of their performance is due to company-specific issues, they can offer an intriguing way for experienced investors with a strong stomach for volatility to diversify more stable areas of their portfolios.
Geographic diversification
While geographic markets have become increasingly interdependent over the past few decades, investing internationally can still reduce risk by spreading exposure across economies that don’t always move in tandem – something to keep in mind as the international trade agreements which tie economies together seem to be unravelling.
United States – the world’s largest market, and home to many of the world’s largest, most innovative and most well-capitalized companies. The U.S. is also home to the world’s most liquid and most secure government bond market. Although the recent political and economic turmoil has had an outsized effect on U.S.-domiciled assets, they remain a core holding for most retirees.
Canada – For Canadian retirees, homegrown equities, bonds and, especially, real estate remain important components of a well-balanced portfolio. While the size of Canada’s market is relatively small compared to others, it gives Canadian investors the ability to invest in several world-renowned businesses (in the financial sector, oil and gas, and mining, in particular) without worrying about currency fluctuations – a key benefit in times of international turmoil.
Europe – In recent times, Europe has become overshadowed by the U.S. and Asia. But it remains home to some of the most well-known companies in the world. And as U.S. policy becomes more inward-looking, European economies are changing by expanding trade, reinvesting in infrastructure and loosening policies that restricted economic growth. All good news for investors.
Asia – home to many of the most dynamic and fastest-growing economies on the planet. Increasingly, companies in Japan, China, South Korea, Taiwan and their neighbours are also some of the world’s most innovative, with technologies and services sold around the world. Growth-oriented investors should definitely reserve a slice of their portfolio for this region.
Emerging markets – these are the “up and comers” of the investment world: countries that are transforming from lower-income economies to more industrialized, high-growth economies. Just the thing for patient, growth-oriented investors.
Frontier markets – beyond the emerging markets are the lesser-known frontier markets: smaller, lower-income countries that are only beginning to open up their economies to international investors: think sub-Saharan Africa, much of South America, the “stans” of Central Asia and the like. Investing in such markets gives investors the chance to get in on the “ground floor” of truly explosive growth – albeit with much greater volatility than other geographic regions.
Style diversification
For those who invest in pooled assets – mutual funds, exchange-traded funds (ETFs) and similar investments – it’s also possible to diversify according to which approach or strategy the fund manager applies to the selection of securities within the larger fund. By blending multiple styles into the portfolio, you can smooth out overall volatility, while seizing opportunities in different market conditions.
The most common styles include:
Growth – this strategy focuses on securities expected to grow at a faster rate than the market average – very common with high-tech companies or those operating in other innovative fields. Low interest rates and a generally bullish outlook for most world economies has led to this strategy performing exceptionally well over the past decade or so.
Value – this strategy focuses on securities that are undervalued, under-appreciated, or unloved by the market and are, therefore, mis-priced. Managers who follow this style aim to buy such securities at a low price, and then wait for a “catalyst” that will lead to the market realizing the true value that was previously hidden or ignored. Generally, the value style often performs best when the market starts to recover after a downturn, or when inflation and interest rates rise.
Income investing – as its name suggests, this strategy prioritizes investments that provide stable or growing dividends or interest payments. The ongoing payments naturally lead to securities that exhibit financial stability in times of volatility, making it an ideal diversification strategy for investors with a more conservative bent.
Momentum – think about this style as a “buy high, sell higher” strategy, emphasizing stocks and other securities that are already showing strong performance; the assumption being that positive performance will continue, at least in the short to medium terms. A strategy that can lead to outsized returns in environments with clear trends.
De-WORSE-ification: diversification mistakes to avoid
One of the great arguments for diversification is that it’s intuitive and easy to understand for even the most novice investors. But this doesn’t mean that it’s always easy. Keep an eye out for the following errors or misunderstandings in how you apply diversification – they can have serious consequences, leading you to believe that you have more protection against volatility than you actually do.
Overdiversification
When it comes to diversification, there is such thing as too much of a good thing. If, in the attempt to diversify, you add so many assets that you simply end up replicating an index or the market as a whole, you haven’t really reduced volatility in any meaningful way. In fact, you may well have reduced the possibility of outperforming the market, and often at a much higher cost than simply buying an index fund or market-tracking ETF.
“Collecting” assets
If you’ve been investing for a while, chances are that you’ve built up a number of assets in your portfolio. But don’t confuse that for true diversification. Diversification is not a collection of random assets built up without any real thought as to how those assets interact with each other. Rather, it’s a deliberate pairing of investments pursued with clear allocation targets and an intentional strategy of reducing risk.
Too much correlation
A common misperception about diversification is that it’s all about holding a great number of assets in the portfolio. That’s only half the story. The key to diversification is to hold assets with uncorrelated performance – that is, assets that perform differently from each other at different times in the market cycle. Without some analysis of how the performance of those assets differs (or doesn’t) from each other, you may have the illusion of diversification, rather than the reality.
Lack of rebalancing
Diversification is not a “set it and forget it” kind of strategy. Over the years, certain allocations will inevitably grow faster than others; over time, these winners can come to dominate your portfolio to the point at which it is no longer truly diversified. To avoid this, get into the habit of periodically rebalancing your portfolio by trimming back some of the winners in order to restore your original diversification target.
Beyond the basics: a final word about diversification
Diversification is one of the simplest, most common-sense and most effective ways of protecting your portfolio from both the financial and psychological consequences of tariff turmoil or political problems. But to be effective, it needs to be enacted deliberately, with a well-thought-out plan and a specific risk management objective in mind.
If you’re interested in learning more about strategic diversification, there are several online apps and research tools that can help you out. In addition, most discount brokerages have analysis tools that can give you an excellent understanding of how well your current holdings are diversified, in what way you can improve your diversification level, and what practical difference any added diversification might make over time.
Perhaps the best tool of all, however, is a qualified professional financial planner or wealth advisor. With in-depth knowledge of assets and markets, along with a full range of back-testing tools and analysis, a professional can determine whether your current level of diversification is sufficiently adequate to let you sleep comfortably in these “interesting times” in which we live.