This week’s charts come from Morningstar’s 2025 Diversification Landscape report.

Diversification has often been called the often free lunch in investing. In 1952, Harry Markowitz established in his landmark research that a portfolio’s risk level isn’t just the sum of its individual components, but how the holdings interact with each other.

This interaction is referred to as correlation. It measures how two securities move in relation to each other (although it captures only the direction and not the magnitude of returns).

A correlation coefficient of 1 means that the two securities are perfectly correlated, and 0 means that they have no relationship.

Combining asset classes with correlations below 1 reduce the risk profile of the portfolio. It is one of the few cases where the whole can be more than the sum of the parts: A well-constructed portfolio can have better risk-adjusted returns than its components. The lower the correlation, the greater the reduction in volatility from adding additional assets.

Risk Reduction in Additional Assets

The problem is that correlation coefficients will shift over time, so what has worked in the past won’t necessarily work in the future. Adding asset classes can also drag down returns.

Below, we can see the risk-adjusted returns over the long-term and test the value of diversification. The chart looks at US stocks and US investment-grade bonds as a baseline for a basic 60/40 portfolio. The diversified portfolio includes a 20% weighting in larger cap domestic stocks; 10% each in developed and emerging markets stocks, Treasuries, core bonds, global bonds and high yield bonds; and 5% each in small cap stocks, commodities, gold and REITs. Each portfolio is tested on a rolling 10-year period starting in 1976.

Risk-Adjusted Returns Sharpe Ratio

Although a broadly diversified portfolio improved risk-adjusted returns vs an all-stock portfolio during most rolling periods between January 1976 and August 2017, the diversified portfolio posted weaker risk-adjusted returns over more periods sinc then. The 60/40 portfolio fared better than the stocks only benchmark 84% of the time.

The full report* looks at how key asset classes performed in 2025, how correlations have changes, and the implications for portfolio building. It digs into the diversification benefits of adding various asset classes and styles to an equity portfolio. It also looks to the future and the diversification strategies for investors.

*2025 Diversification Landscape Report, Amy C. Arnott, CFA, Portfolio Strategist; Christine Benz, Director of Personal Finance and Retirement Planning; Jason Kephart, CFA. Senior Principal, Multi-Asset Strategy Ratings; Karen Zaya, Ph.D., Associate Director, Multi-Asset & Alternative Strategies.

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