The Complete Guide to Portfolio Diversification
Why Diversify?
Diversification is the only free lunch in investing. By spreading your capital across uncorrelated assets, you can reduce risk without necessarily sacrificing returns.
The Core Principle
When one asset falls, another may rise — or at least fall less. The key is correlation: assets that don't move in lockstep provide better diversification.
| Asset Pair | Typical Correlation |
|---|---|
| US Stocks & Int'l Stocks | 0.75 (high) |
| US Stocks & Bonds | -0.20 (low/negative) |
| US Stocks & Gold | 0.05 (near zero) |
| Bonds & Gold | 0.15 (low) |
The 5 Core Asset Classes
- **US Stocks (SPY)** — Growth engine, highest long-term returns (~10% CAGR), highest volatility
- **International/European Stocks (STOXX50E)** — Geographic diversification, different economic cycles
- **Bonds (AGG)** — Stability, income, crisis buffer (~4% CAGR, low volatility)
- **Gold (GLD)** — Inflation hedge, crisis safe haven (~7% CAGR, uncorrelated)
- **Emerging Markets (EEM)** — High growth potential, higher risk, demographic tailwinds
Classic Portfolios
The 60/40 Portfolio: - 60% US Stocks, 40% Bonds - Historical CAGR: ~8.5%, Max Drawdown: ~-30% - Pros: Simple, battle-tested - Cons: Struggled in 2022 (stocks and bonds fell together)
The All-Weather Portfolio (Ray Dalio inspired): - 30% US Stocks, 40% Bonds, 15% Gold, 7.5% Commodities, 7.5% Int'l - Historical CAGR: ~7.5%, Max Drawdown: ~-15% - Pros: Very low drawdowns, steady growth - Cons: Lower returns in bull markets
The Golden Butterfly: - 20% US Stocks, 20% Small-Cap Value, 20% Long Bonds, 20% Short Bonds, 20% Gold - Historical CAGR: ~8%, Max Drawdown: ~-15% - Pros: Excellent balance of growth and stability
Common Diversification Mistakes
- **Over-diversification** — Owning 15 ETFs that overlap heavily gives a false sense of diversification
- **Home bias** — Investing only in your home country ignores 50%+ of global opportunities
- **Ignoring rebalancing** — Without periodic rebalancing, your allocation drifts and risk increases
- **Chasing performance** — Adding last year's best-performing asset class usually means buying high
How to Use Vesta Covarianz
Use our Portfolio Builder to experiment with different allocations. The backtest engine shows you exactly how each combination would have performed across decades of market history — including through major crises.