Diversification may seem like a quaint topic in 2025…
Looking at the top year-to-date sector returns for the S&P 500 tells an interesting story:
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Communication Services: up 16.90%
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Industrials: up 14.84%
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Information Technology: up 13.54%
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Utilities: up 11.79%
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Financials: up 10%
All have outperformed the broader index. And, with perhaps the exception of industrials, the top sectors have one thing in common – they’re tied (directly or indirectly) to the artificial intelligence (“AI”) trade.
Communication is self-explanatory. Google and Meta are in there. So is technology. That’s where Nvidia, Broadcom, and Microsoft are housed.
If you’ve been reading these pages, you know why utilities are up. AI data centers are very power hungry. Financials might not appear connected to AI, until you remember that the buoyant markets have led to a wave of new IPOs – Figma, Circle, and CoreWeave being the big ones.
In some real sense, AI is the only game in town.
That’s not necessarily “bad.” And we do have plenty of exposure to the AI industry in our own model portfolios.
But the market of tomorrow might look very different from the market of today. And it wouldn’t hurt to prepare for that possibility. As tempting as it is, you never want to go to heavy into one sector, idea, or company.
I learned that the hard way.
Remember, I was overweight in real estate in my previous life as a developer – and I paid an almost bankrupting price for it.
No matter how attractive an investment category might look and might even actually be, it isn’t perfect. Markets change. Companies change. Sentiment changes. Nothing is certain, no matter how “certain” they seem.
So, yes, diversification still matters… even in the age of AI.
Here’s another way to think about it.
Salsa: Always a Mix of Ingredients
Around a decade ago, I interviewed Dr. Craig Israelsen, a professor of personal financial planning at Utah Valley University. He had a great way of framing the concept of portfolio diversification:
Great salsa is all about diversification. Only by adding diverse ingredients together can we achieve the desired outcome. However, there are some ingredients in salsa that most of us would never want to eat individually, like hot peppers or Tabasco sauce. But without the “hot” ingredients, the salsa would be flat.
Similarly, investment portfolios should include a wide variety of diverse ingredients, or “assets”… Each investment asset adds an important dimension to the portfolio because each asset behaves differently. This diversity is vitally important in salsa… and in portfolios.
There are plenty of ways to make salsa. But they all have one thing in common – you’ll need a whole host of ingredients, preferably ones that complement each other. Think of your portfolio the same way.
Similarly, I can’t ethically prescribe an exact portfolio formula for any one person. I don’t know whether you can afford a “spicier” life with more risk, or if you need to keep it milder. Nor do I know whether you’re better suited to classic “recipes” or less traditional allocations.
That’s ultimately something you need to decide yourself – perhaps with the help of a financial planner who does know your specific considerations – based on factors such as:
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Age
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Income
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Debt situation
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Family situation
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Current needs
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Retirement goals
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And more…
Do you have your mortgage paid off? Are you a do-it-yourself investor? Are you still trying to pay for your kiddos’ college educations like I am?
Your specific answers factor into what you should invest in and by how much. All I can reiterate is that you shouldn’t be only invested in one idea, even a very promising technology like artificial intelligence.
So, yes, have some exposure to the AI trade. But maybe have a look at some other high-quality, deeply discounted assets that are out of favor (for now). That’s why I’ve spent so much time covering real estate investment trusts (“REITs”) in recent issues.
Mr. Market may be ignoring REITs – and commercial real estate in general – for now. But who knows what tomorrow will look like?
Life demands variety. That’s true of salsa… and portfolio allocation.
Regards,
Brad Thomas
Editor, Wide Moat Daily
P.S. Speaking of portfolios, Wide Moat analyst Nick Ward will reveal his personal portfolio picks on our YouTube show this week. And he’ll be doing so in particularly “diversified” attire.
If you haven’t seen his special jacket yet, I highly recommend you tune in to Thursday’s Wide Moat Show. Come for the colors. Stay for the valuable information that can help you sleep well at night.
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