One of the strangest things about diversification is that, if it is working properly, part of your portfolio will almost always disappoint you.

That sounds counterintuitive. Surely the whole point of investing is to own the things that perform best?

But that is exactly the trap.

If every investment in your portfolio is rising at the same time, for the same reasons, and responding to the same economic forces, you may not be as diversified as you think.

That is why I am perfectly comfortable owning investments that underperform.

Over the last decade or so, US equities, particularly the largest technology companies, have been extraordinarily strong.

That has made the S&P 500 the obvious benchmark for almost everything else. It is cheap, simple, full of world-class businesses and has delivered excellent long-term returns.

When you compare other markets against it, they can sometimes look rather disappointing.

UK equities have spent long periods lagging. Asian markets have been inconsistent. Smaller companies have endured frustrating stretches. Even a diversified global portfolio can look pedestrian next to a surging US market.

It is very easy to look at that and conclude that diversification has failed.

I think that is the wrong conclusion.

My own portfolio deliberately spreads money across different markets and different types of companies. I have a large developed-world core, a dedicated S&P 500 allocation, UK equities, Asia-Pacific exposure and smaller companies.

I do not expect all of them to outperform at the same time.

In fact, I would be surprised if they did.

UK equities give me greater exposure to sectors such as financials, energy, materials and mature dividend-paying companies. Small caps take me further down the company-size spectrum. Asia gives me exposure to another part of the global economy, while the S&P 500 ensures I retain a meaningful allocation to the biggest companies in the world’s largest stock market.

At any given moment, one of those areas is likely to look better than the others.

That is not a problem. That is diversification doing its job.

And 2026 has already provided a pretty good example.

After years in which US equities seemed almost impossible to beat, my UK equity income holding and Asia-Pacific fund have both outperformed my S&P 500 holding so far this year.

As of early August, my Vanguard UK Equity Income fund was roughly 17% higher than around the start of the year, while the Developed Asia-Pacific ex-Japan ETF was up around 35%. My Vanguard S&P 500 ETF was up roughly 13% in sterling terms.

A year ago, many investors might have looked at UK or Asian equities and wondered why they bothered owning them at all.

Then the relative performance changed.

Quickly.

That does not mean UK or Asian equities will continue outperforming. I have absolutely no idea whether they will. But it shows that maintaining a diversified portfolio can reward long term investors.

The real risk comes when investors start removing whatever has disappointed them most recently.

Imagine holding an investment for several years while watching the S&P 500 race ahead. Eventually frustration takes over. You sell the laggard and move the money into the winner.

Then the cycle changes.

You have effectively sold what was unpopular and bought what had already performed strongly.

That is one of the easiest ways to turn long-term investing into performance chasing.

None of us knows which market will lead over the next decade. We can study valuations, interest rates, earnings and economic growth, but we still cannot know with certainty what comes next.

I would rather accept that uncertainty than pretend I can consistently identify the next winner in advance. The Developed Asia pacific region is a good example of this; my ETF in this part of the world was flat for nearly 4 years - but then shot up over 60% in the last year. You never know what is around the corner…

An investment failing to beat the S&P 500 does not automatically mean it is a bad investment. The better question is whether it is still doing the job I bought it to do.

If I own UK equities to diversify my geographical and sector exposure, their purpose is not necessarily to beat US technology companies every year. The same applies to Asia or smaller companies.

There are genuine reasons to change an investment. Fees may become uncompetitive, a fund may change strategy, or my own objectives may change.

But “it hasn’t beaten the S&P 500 recently” is not, by itself, a particularly convincing reason.

If the S&P 500 has another exceptional year, I will probably wish I owned more of it. If UK equities surge, I will wish I had more there instead.

That does not mean the portfolio is wrong. It simply means I diversified.

The objective is not to own yesterday’s best-performing investment in exactly the right quantity. The objective is to build a portfolio capable of surviving many different versions of the future.

Because diversification does not mean everything wins.

It means I do not need to know in advance which investment will.

The Compounder
Long-term investing made simple.

The Compounder is for financial education and commentary only. I am not authorised or regulated by the Financial Conduct Authority and I do not provide financial advice, investment advice, or personal recommendations. Nothing published here should be taken as a recommendation to buy, sell, hold or switch any investment, fund, pension, ISA, crypto asset or financial product. Always do your own research and consider speaking to an FCA-authorised financial adviser if you are unsure.