Diversification Was Never Broken

"The tortoise doesn't look impressive during the race. The tortoise never does. But the tortoise always finishes the race."

— Erik Strid

A word has been showing up in the financial press lately in a way Erik finds both amusing and revealing. Commentators have begun describing diversification as though it is suddenly working again, as if it had ever stopped working, as if the tortoise had taken a very long nap while the hare ran away with the race. In this month's episode, Erik makes the case that the framing is exactly backwards.

Drawing on two decades of first-hand experience, Erik walks through the eerie parallels between the late 1990s internet bubble and the artificial intelligence narrative driving markets today, what actually happened to diversified investors when the dot-com bubble burst, and why the recent rotation in market leadership is not a surprise at all. It is diversification doing precisely what it has always done.

Two Bull Markets, One Script

The moment we are in right now looks a great deal like a moment we have been in before, and understanding that history is essential to understanding what comes next.

The greatest bull market in American history ran from August of 1982, when the S&P 500 sat at a low of approximately 140, all the way to March of the year 2000, when it peaked at 1,527. That is a compounding rate of over 19% per year for nearly 18 years. Nothing like that had ever been seen before, and in its final years it was powered increasingly by a single narrative, which was the transformational promise of the internet and the new economy the internet was going to create.

The current bull market began at the bottom of the financial crisis, when the S&P 500 bottomed at 677 back in March of 2009. From there it has compounded at approximately 16% per year for over 17 years, carrying us to roughly 7,500 today. And in its final years, it too has been powered by a single dominant narrative, artificial intelligence and the companies leading the AI revolution.

In both cases the markets delivered extraordinary returns over about 17 or 18 years. In both cases the late stage of the bull market saw performance narrow dramatically to a handful of technology companies that seemed to embody the spirit of the age. And in both cases, investors who weren't fully concentrated in those tech companies were made to feel foolish for their diversification. The parallels are eerie, and they are also instructive.

What 1999 Felt Like From the Inside

I was in the business of wealth advisory then, and I want to tell you what it actually felt like. Between 1995 and the year 2000, growth stocks, and technology stocks in particular, dominated everything. The Russell 1000 Growth Index outperformed the Value Index by over 10 percentage points per year during that five-year stretch. Cisco Systems, at its peak, became the most valuable company in the world. AOL merged with Time Warner in what was then the largest corporate deal in history. And companies with no earnings and no clear path to profitability were going public almost every day and doubling on their first day of trading.

The investors who owned traditional diversified portfolios, value stocks, financial companies, industrials, small caps, international equities, were being crushed in relative terms. Some of them were even losing clients because of it.

I can remember conversations from that era that are burned into my memory. Clients demanding to know why we owned old economy stocks, why we owned companies that made things or sold things or built things instead of riding the internet wave. The words "old economy" were not a neutral description. They were an insult. They meant you're behind the times, you're slow, you're destined for the dustbin of history. Does that all sound familiar?

The Experience Was Not the Same for Everyone

When the dot-com bubble burst in March of 2000, the results were dramatic. But here is what I want you to notice. The experience wasn't the same for everyone. It was the diversified, so-called old economy investor who cushioned the blow.

The Russell 1000 Growth Index, dominated by tech and internet companies, fell by about 22% in 2000, another 20% in 2001, and an additional 28% in 2002, a cumulative loss of about 56% over three years. The Nasdaq, where most of the speculative names were concentrated, fell by nearly 78% from its high to its low.

But the Russell Value Index, the old economy stocks, the ones clients were embarrassed to own, told a very different story. Value stocks fell only modestly in 2000 and were largely flat in 2001. And then when the recovery began, they actually led the way. From 2000 through 2006, Russell 1000 Value outperformed Growth by roughly 10 full percentage points per year. That was a seven-year period during which the investors who had maintained diversification weren't just recovering, they were building real wealth while the concentrated technology investors were still trying to get back to even.

Twenty-Five Years Later, the Same Conversations

Fast-forward to the last several years, and the script has been remarkably similar. Between 2023 and 2024, the Magnificent Seven, NVIDIA, Microsoft, Apple, Alphabet, Amazon, Meta, and Tesla, rose a collective 156%, while the remaining 493 companies in the S&P gained just 25%. In 2023 alone, the Mag Seven surged by 75% while the S&P 493 returned only 12%. By late 2024, these seven companies represented almost 35% of the entire S&P 500 by market weight. The market had not been concentrated in this handful of names since, you guessed it, the dot-com era.

And the conversations we were having as wealth advisors were achingly familiar. Why do we own small caps? They've been dead money for years. Why international? It's had a decade of underperformance. Why not just put everything in NVIDIA? At the peak of concentration in mid-2023, only about 1% of the S&P 500 companies, five stocks, were outperforming the Mag Seven's average return.

These were not stupid clients asking stupid questions. They were paying attention. They were doing the math, and the math said concentration works, so why are we fighting it? The answer, then as now, is that the math of the recent past is never the math of the future, and history is quite consistent on this point.

The Last Eight Months

Which brings us to the last seven or eight months, and the numbers here are striking. The Mag Seven, as a group, are down roughly 3% or 4% for 2026 through mid-year. Five of the seven are trailing the S&P 500. Tesla has fallen by about 29%, and Microsoft is down by more than 20%.

And yet the S&P 500 itself is up roughly 8% to 10%. How? Because the other 493 companies have finally had their moment. Small-cap stocks are up about 21% year to date. Mid caps are up about 15%. Emerging markets, which had been dismissed as a chronic underperformer for the better part of a decade, are now up about 30% over the last year. Even dividend stocks are up close to 12%.

The broadly diversified investor, the one who maintained their allocation in all these so-called laggards through the years of underperformance and pressure to abandon them, is not just keeping up. They're shooting the lights out right now.

The financial media, to their credit, have noticed this. But how they've described it is revealing. "Diversification is suddenly working again," said one headline, as if it had been broken or stopped working, as if the tortoise had just woken up from a very long nap. But diversification was never broken. It was doing exactly what it always does, ensuring that when one part of the market is overextended and ready for a correction, other parts of your portfolio are there to carry the weight. The parts that felt like dead weight in 2023 and 2024 are the parts that are generating the returns in 2026. This isn't an accident. This is the whole point of investing.

An Honest Word About What Comes Next

Let's be honest about something, because intellectual honesty is one of the things I hope this series stands for. I don't know whether the current rotation is the prelude to a broader market correction, a replay of 2000 where the air coming out of the speculative bubble caused significant pain across the entire market before things broadened out, or whether we're just experiencing the healthy, long overdue broadening of market leadership without having to pay the full price of a major bear market.

Both scenarios are consistent with the history I've described, and both are certainly possible. The S&P 500, for all its recent broadening, still trades at roughly one full standard deviation above its 30-year average on a price-to-earnings basis. The bull case is that earnings growth of nearly 19% expected in 2026 justifies that valuation. The bear case is that the market has no margin for error. Both are legitimate arguments, and I'm genuinely uncertain which one is going to prevail.

But here's the thing. I don't need to know, and neither do you, because the lesson of the last two and a half decades is not to pick the scenario correctly. The lesson is to build a portfolio that works reasonably well across multiple scenarios and then stay invested through all of them. The diversified, rebalancing investor does well if the market broadens without a crash, and they do better than the concentrated investor if there is a crash. In neither scenario are they the winner in any given year, but over the course of the whole race, the tortoise always wins.

Own the Transformation, Not the Guess

I'd like to close with what I think is the most important insight of this entire episode, and it's one I feel strongly about because it reflects something I've come to believe deeply after watching the internet revolution unfold from beginning to middle to where we are now.

In the late 1990s, the right response to the emergence of the internet was not to put all of your money into Cisco Systems or AOL or Webvan. Many of those companies went to zero. The internet was genuinely revolutionary, probably even more revolutionary than even its most fervent advocates might have imagined back in 1999. But it was also impossible to pick the specific winners in advance. There was enormous mal-investment. There was fraud. There were brilliant ideas that failed because the timing was wrong, or the capital structure was wrong, or the business model was wrong. The graveyard of dot-com companies is vast. We laugh about it today.

And yet the internet did make the American economy enormously more productive and profitable. Not primarily by creating a handful of dominant internet companies, but by being adopted as a tool by every business in the country. Think about the airline that built a website and let customers book their own flights, the retailer that cut its supply chain costs with real-time inventory management, the law firm with searchable databases, the hospital that digitized its records, the manufacturer that connected its factories to its suppliers. These businesses, the so-called old economy companies that were laughed at back in 1999, became dramatically more efficient, more profitable, and ultimately more valuable because of the internet. And that's where the real return was, not in betting everything on which internet company was going to win, but in owning all of American enterprise as it was transformed by this technology.

I believe, and I hold this view with genuine conviction, that artificial intelligence is going to follow exactly the same pattern. I'd never bet the farm on whether OpenAI or Anthropic or NVIDIA is going to produce the most durable return for shareholders. These are impossible questions, and the history of transformative technology suggests that the odds of picking the right winner in advance are really low.

But I am highly confident in this. Within the next decade, virtually every company in the S&P 500 is going to be using AI to do more with less. They're going to be serving customers better, managing inventory more efficiently, writing better software faster, identifying fraud before it happens, reducing administrative waste. They're going to find the molecule that cures the disease. The companies that will benefit most from AI probably don't have AI in their names. They may be the insurance companies and grocery chains and shipping companies and banks. They may look to the investor of 2026 exactly the way old economy stocks looked in 1999: boring, unfashionable, and destined to be left behind.

That's what a diversified portfolio of equities gives you, and that's why I like to own the whole market, rebalance it regularly, and never abandon it because one part of it is temporarily outperforming everything else.

So in closing, the financial media is treating diversification's recent success as if it's a surprise, a trend that suddenly started working again. I hope I've made the point that it was never broken. It was working the entire time. It was working in 1999 when your value stocks felt like an anchor, and it was working in 2023 when your small cap stocks felt like dead weight. It was working every time you rebalanced, selling a little bit of what had run and buying a little bit of what had lagged, and it felt like exactly the wrong thing to do. The tortoise doesn't look impressive during the race. The tortoise never does, but the tortoise always finishes the race.

Helping those you care about

The purpose of our Great Investors series is to help you become an outstandingly successful investor by following the principles of patience and discipline required to prosper as an equity investor. No doubt, "Mr. Market" periodically tests that patience and discipline by subjecting investors to emotional swings, possibly causing many to make a big mistake. Only those who faithfully adhere to a rock-solid investing philosophy will pass those tests.

Successful investing, while always fundamentally simple, will never be easy. You may have a family member, colleague, or friend who perhaps has not fared as well recently, and who you feel might have benefited from the sort of advice you're receiving. Should that be the case, we would certainly appreciate your introducing us to them. We very much enjoy working with you and would welcome the opportunity to offer the same level of planning and service to the people you care about.