Don't Get Swept Away by 'S&P 500 Envy' as Stocks Smash Records

When stocks are performing well and bonds are struggling, as is currently the case, it can be challenging to persuade investors of the importance of diversifying their portfolios with both asset types. Investors often focus on their account statements, comparing their returns to the eye-catching figures they hear about in the news — for instance, the S&P 500 is up nearly 12% year-to-date by mid-May, and the Dow Jones Industrial Average recently hit 40,000. When their returns are lower, they experience what is known as “S&P 500 Envy.”

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This phenomenon isn’t new. While both stocks and bonds were down in recent years, similar market conditions in 2018 also fueled “S&P 500 Envy.” BlackRock, a major investment firm, even created a presentation for financial advisers titled after this concept to help explain it to their clients. The objective was to illustrate that although a diversified portfolio might underperform the S&P 500 in the short term, it can yield better results over the long term. BlackRock declined to comment for this article.

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A core graphic from BlackRock, updated for 2023, highlights this issue. It shows a sad face for years like 2000-2002, 2008, 2020, and 2022 when the S&P 500 was down, and a diversified portfolio was down by less. Investors in these scenarios might think, “I lost money.” For the years 2009-2019 and 2023, when the S&P 500 was significantly up while the diversified portfolio lagged slightly, the sentiment is, “I didn’t make as much.” The overall takeaway from the graphic is that despite these feelings, diversification can be effective over time.

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Nicholas Olesen, a certified financial planner with Kathmere Capital Management near Philadelphia, used similar reasoning in a 2018 video presentation and believes it still applies today. He points out that advising clients to diversify is more challenging when the S&P 500 has been performing well for an extended period. Clients often question why they shouldn’t invest solely in the S&P 500, as it appears to be the only thing that’s working.

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Olesen’s counterargument emphasizes that diversification is beneficial in the long term because it mitigates the risks associated with the volatility of different economic sectors. He explains that while the S&P 500 has performed exceptionally well recently, there will be times when other investments perform better. This idea is supported by the concept of “recency bias” in behavioral finance, which suggests that investors tend to believe that recent trends will continue indefinitely. This bias can lead them to abandon a well-balanced 60/40 portfolio in favor of an all-equity approach, which can backfire during market downturns.

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Advisers often advocate for a long-term perspective and a balanced approach, designing a portfolio with a mix of stocks and bonds tailored to the investor’s personal circumstances and sticking to the plan despite market fluctuations. Olesen notes, “Diversification is not designed to give you the greatest performing portfolio right now; it’s designed to give you the results you want long-term.”

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Ross Haycock, a certified financial planner with Summit Wealth Group in Colorado Springs, Colorado, echoes this sentiment. His firm regularly addresses “S&P Envy” on its website. He likens diversification to the old adage, “Don’t put all your eggs in one basket,” and emphasizes the benefits of having different investments over time. Haycock finds that longstanding clients, who have experienced market ups and downs, are more receptive to this advice. However, newer clients may need more reassurance during turbulent times.

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Investors’ reluctance to diversify often stems from their aversion to bonds, which have suffered in recent years. For example, Vanguard’s Total Bond Market Index ETF was down 1.26% year-to-date in mid-May and down 9.23% over the past five years. Investors tend to focus on the declining prices of bonds rather than their yields. Although bond prices may fall, they continue to generate consistent yields, and lower prices typically result in higher yields.

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Olesen warns against “statement shock,” where investors see a quick snapshot of their portfolio performance without understanding the full context, such as bond yields. He advises looking at a time-weighted return performance to get a clearer picture of an investment’s value. This reinforces the importance of a well-considered investment plan and sticking to it, rather than making decisions based on short-term market movements.

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Haycock adds that emotional decisions driven by fear of missing out (FOMO) can undermine financial stability. He encourages investors to think rationally about their financial strategies and to understand the long-term benefits of diversification.

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