The secret sauce of a resilient portfolio

So far, 2025 has excelled in one thing: uncertainty.

Uncertainty around tariffs, tax policy, geopolitics, inflation, the direction of interest rates – the list is long.

And if there is one thing that fuels market volatility, it’s uncertainty.

Volatility is a natural part of the market, so it’s unavoidable when investing. Still, you want to protect your wealth and reach your retirement goals. So how can you help your portfolio do this amid all of today's unknowns?

That’s where diversification comes in.

Some think of diversification as an old musty concept that simply involves investing in different asset classes, so that when one asset class zigs, another zags to offset it.

Wrong.

Let's discuss what diversification is really about because in uncertain times, we're as certain as ever it's what your portfolio needs.

Decreasing risk is just part of the story

A primary reason that diversification is a cornerstone of our investment approach is its potential to decrease risk, especially during volatile markets.

If you think about it, it makes perfect sense that diversifying risk can lower it.

Let’s take the risks created by tariffs. We don’t know how tariffs themselves will play out on the world stage, much less how exactly each individual stock or bond will respond to them.

We can assume some stocks and bonds will suffer more price declines than others. If your portfolio is diversified across securities, asset classes and geographies, it’s not as exposed to the specific stocks and bonds with the worst losses. In this way, diversification helps spread out risk (though it can’t eliminate it).

Diversification seeks to optimize returns

Ultimately, the goal of diversification is not only to decrease risk but to do so while optimizing returns over time. Because diversification can help grow a portfolio with lower risk over the long term, it’s been called the only free lunch in investing.

How does this work? By holding a large number of securities within an asset class, you can increase the odds of holding the biggest outperformers. This is particularly seen with stocks where just a few outperformers tend to drive the gains of the overall stock market.

Consider that just 2.4% of top-performing stocks accounted for all the global stock market’s wealth creation between 1990 and 2020, according to a major academic study.

Diversification in action

How confident are you that you can predict which stocks will be the top performers – and worst underperformers – over the next several years, much less over the next several decades? Being highly diversified has been part of the solution.

Take the MSCI ACWI Index, also known as the “All Country World Index.” It has thousands of stocks chosen from different sectors from markets around the world. The index’s overall return was higher than any of its typical stock over the recent one-, three- and five-year periods. Yet, the index’s volatility over those periods is less than half that of the index’s typical stock.

That index only consists of stocks. Now, think of the potential that diversification has when other asset classes are used. Keep in mind, asset class allocations would need to work together to help optimize return and lower risk. Turns out that diversification is more complex than it may seem.

When most asset classes are declining, what’s the value of diversification?

One can counterargue that the global uncertainty created by tariffs and inflation will affect prices across asset classes, so diversification won’t help. Actually, diversification still helps.

It’s true that some research has shown that the globalization of financial markets and cash flows has corresponded with asset class prices in different geographies moving together more than they did in the past. In the U.S. alone, stock and bond prices in the last few years have been more correlated than they have been historically.

While macro developments like inflation and tariffs may affect both stocks and bonds, they may not affect them equally, nor may they affect all geographies equally. As of late March, bond returns are outpacing stock returns in the U.S. and stock returns of foreign developed markets are outpacing U.S. stock returns.

Diversification isn’t a guarantee against losses. But, if your portfolio is highly diversified, any loss could end up being much less than a portfolio concentrated in a few stocks and in one country. Plus, high portfolio diversification helps ensure exposure to wherever there may be positive returns.

Bottom line: You need to stay invested to reap the potential benefits of diversification.

Our diversified portfolios are designed to take on market uncertainty

While a diversified portfolio seeks to optimize returns on lower risk, it needs to do so by incorporating your specific time horizon (such as your retirement date) and your risk tolerance.

These are among the reasons that your portfolio should be professionally managed. For example, Edelman Financial Engines diversifies across 16 asset classes and thousands of securities using proprietary methods that take into account correlations and other risk factors. We then create different portfolio allocations that reflect individual goals and risk levels.

No matter how carefully a portfolio is diversified, eventually the diversification will be thrown off by market action. A portfolio needs to be rebalanced, so its allocations remain aligned with your goals.

Rebalancing itself can impact returns and can result in unwanted tax consequences if not done right. In times of increased volatility like these, we may rebalance more often to help prevent portfolio allocations from drifting too much.

We are monitoring the markets and expect this year could involve a lot more surprises, but our diversified portfolios are designed to take them on. If you have an Edelman Financial Engines diversified portfolio, so is yours.