Does diversification really help?

You must have heard the phrase - diversify, diversify, diversify. So how does one diversify?

The first step of diversification is to break your overall portfolio into

Equity (stocks)
Fixed income (cash or bonds)
and a third category that I'll call "commodities" (precious metals, energy, food products and heck even real estate).

Now within your equity allocation you diversify across countries (developed and emerging markets), across market cap (large, small companies), across value and growth and across sectors (energy, tech, Industrials)

Within your fixed income you diversify across Money market accounts, Fixed deposits, Short/Mid/Long term bonds, Govt bonds, TIPs, treasuries etc etc

Within commodities - you diversify across energy, precious metals, agriculture

OK, so lets say you did diversify your portfolio - try to put it to a real test - go back 10 years (or more) to spot a trend. You might see the following:

1) During a market downturn, your bonds/cash would have cushioned the fall
2) During a bull market - heck everything does well (maybe not bonds and cash as much)
3) Commodities are a good diversifier since they do not have a strong corelation with stocks or bonds and follow their own cycles
4) During (or due to) a downturn in the US market, international stocks (non-US) and emerging markets get hit much harder, but also bounce back much stronger

Moral of the story of-course being - don't put all your eggs in one basket - spread 'em around so they all don't all get crushed at once! Also, remember the popular saying - "There's always a bull market somewhere" - well if you are well diversified, chances are that you'll catch some of it :-)

How does one create a simple, yet fully diversified portfolio - coming up.....