The market optimism that greeted the start of 2025 has turned sour. Once buoyed by the prospect of continued economic growth, interest rate cuts, tamed inflation, and deregulation under the Trump administration, investors are losing confidence, with sentiment shifting to caution and fear. Fear of recession, rising inflation, tariffs, higher interest rates for longer, global unrest, and anxiety for what shoe might be the next to drop. US debt is already at 100% of US GDP and growing.

The Trump administration intends to extend tax cuts from the 2017 Tax Cuts and Jobs Act and help pay for them by ‘right-sizing’ the government and reigning in spending. Balancing economic growth and government cuts will be tricky, not unlike the Fed’s efforts to engineer a soft landing by raising rates — but not too much post-pandemic. The Trump administration is betting on short-term pain for long-term gain. It’s a challenging balance, and a nudge too far in any direction may have unexpected consequences.

If ever there was a time for diversification to shine, it’s now.

We’ve written about it ad nauseum. It’s one of our investing mantras: proper diversification is one of the keys to long-term investing success. Still, for years, investors asked why we should hold international and emerging market stocks when US markets have been on a tear. No one is asking about that today.

It’s true that US markets have outperformed international markets almost every year over the last decade. But so far this year, the tables have turned. Year to date, international markets have outpaced US markets, with developed international stocks up 6.4%, emerging markets up 2.1% in contrast to the S&P 500 which is down 4.6%, the DJIA, down 1.3% and the NASDAQ, down 10.4%. So, should we hold any US stocks at all, amidst so much uncertainty around policy? Should we just retreat to cash and gold? Our answer: We have to remain diversified in the face of uncertainty. No one can predict which segments of the market will turn and when.

If everything in your portfolio is always moving in one direction — whether that’s up or down — it’s a clear indication that your portfolio is not well diversified. Diversification isn’t about quantity, or having lots of investments. You can hold many stocks and not be diversified at all (think a portfolio of technology stocks). A portfolio that is properly diversified with asset classes with different exposures to risk and differentiated sources of return will include investments that are down and others that are up. That is the result of diversification.

The chart below illustrates how diversification across asset classes can mitigate risk. The annual performance of different asset classes are ranked from the best performing — shown in the top row —to the worst performing in the bottom row. Over the last 10 years, the S&P 500 (e.g. proxy for US stocks) outperformed international developed equities (EAFE) and emerging markets stocks (EM) almost every year. But so far this year, EAFE and EM stocks have performed better than the S&P 500, which is near the bottom year to date. Even bonds are outperforming US stocks so far.

The line running horizontally through the chart below represents a diversified portfolio of all asset classes and illustrates how having a diversified portfolio means you’ll never be at the very top, but you’ll never be at the very bottom either.

In addition to diversifying within stocks and bonds, private markets or alternatives can be an excellent diversifier in a portfolio. Lately, alternatives have gained in popularity among investors who are looking for diversification beyond stocks and bonds. While alternatives like real estate, commodities, private equity and private credit can be effective diversifiers in your portfolio, they are not immune to economic forces, policy changes, and other kinds of risk. Each alternative investment will have its own unique risk and return profile that may be differentiated from equities and bonds but exposed nonetheless to risks (and opportunities) specific to that asset class, sector or strategy.

For example, investments in energy transition experienced significant tailwinds accelerated by President Biden’s Inflation Reduction Act. Those tailwinds have turned into headwinds today, with the Trump administration’s priority on fossil fuels. Similarly, regulatory and policy changes can impact a range of investments — positively and negatively — from health care to real estate to technology, and even municipal bonds.

No one knows exactly what may come to pass and what the potential impact might be, which is why diversification — across international borders, sectors, sizes and asset classes — is so critical.

The only thing we can be sure of going forward is change. When it comes to investing, trying to react to every change is like chasing a moving target. Diversification provides some protection against the unpredictable and the unknowable. Proper diversification and a long term view can help mitigate fears that can drive investors to make poor investment decisions. Investing is a long game and a properly diversified portfolio will help you stay in it for the win.