By Joseph Valerio, CFP®

In light of the recent College Football playoffs and championship game, let's take a unique approach to understanding the importance of portfolio diversification. If you've ever watched college football, you know that some teams dominate one season while others surprise everyone with a season full of mistakes. The same goes for the stock market.

In any given year, knowing which team will win and which team will lose is more or less a shot in the dark. The only thing we can be sure of by the end of the season is that some teams will outperform and others will underperform—it’s a zero-sum game!

For those of you who have been with Northstar for a while, this concept might sound very familiar. In keeping with this theme, consider each asset class we hold in your portfolio to be like a college football team. In some years, your team does well; in others, well, not so much.

A Bet on the National Champion: What If I Gave You $1,000?

Imagine I gave you $1,000 at the beginning of this college football season and asked you to bet on which team would finish as the national champion. You’d have a good idea of the favored teams heading into the season, but by the end, you’d likely be very surprised by the result.

Injuries happen, coaches and players fail to meet expectations, and now, players enter the transfer portal. There’s a lot going on during the season that’s impossible to forecast, and that unpredictability could affect your bet’s outcome.

The same is true for your stocks. In our example above, let’s take the top 10 favored teams and consider each of them to be an asset class in a well-diversified portfolio. For example, let’s say Alabama represents U.S. growth stocks, Georgia stands for U.S. large caps, and others each represent different sectors and regions.

The Risk of a One-Bet Strategy

If I gave you that $1,000 and told you to place your bet on only one team (or one asset class), the sensible thing would be to choose the favorite, or at least the team with the most attractive odds.

But here's where it gets tricky. By the end of the season, you'd be hoping that factors outside of your control—injuries, coaching decisions, or unexpected upsets—don’t bring your bet crashing down. While the odds might favor your pick at the start of the season, in the world of college football, things don’t always go according to plan. The same can be said for stock investing.

You could choose to invest heavily in a single asset class—perhaps growth stocks, tech stocks, or even an individual company. While your pick might seem like the obvious "favorite" at the start, the risk involved is high. The market, like college football, can be full of surprises: unexpected political changes, economic shifts, or sector-specific risks.

In the end, a bet on a single team (or asset class) could leave you vulnerable to losses, just like a failed national champion bid.

To illustrate this point, below you’ll find a quilt chart mapping the top nine college football teams by their end-of-year rankings from 2010 to 2023. This chart underscores the idea that while certain teams may boast a legacy of strong performance, past success is not a guarantee of future dominance.

In our last newsletter, we explored a broad overview of the historic performance of U.S. stocks, particularly U.S. growth stocks. In this analogy, these stocks are akin to Alabama in college football—a powerhouse with a storied and dominant run. But even the mighty Crimson Tide is not immune to change. Coaches retire, NIL deals foster new competition, and the unpredictable inevitably disrupts the status quo.

Over time, even the best experience periods of underperformance.

The Power of Diversification: Multiple Teams, Multiple Bets

So, how can we manage that risk? The solution is diversification. Just like betting on multiple teams, investing across various asset classes gives you better chances of overall success. In our football analogy, let’s say we place small bets on five or six teams across different conferences—one on Alabama, another on Georgia, and a few on mid-tier teams. Even if your top-ranked teams falter, a surprise team could win it all, and you still have a chance to profit.

Similarly, in a well-diversified portfolio, you're not betting everything on one stock or sector. Instead, you're spreading your investments across a range of asset classes—growth stocks, large-cap stocks, bonds, international equities, etc. This strategy provides a balance that can help you withstand the unpredictability of the market.

Below, you’ll find another chart, but this time, instead of charting the variance of college football successes and failures, we’ve done the same thing with different asset classes, assigning each asset class a different color and ranking them from top to bottom based on their performance over the last 15 years.

You’ll notice that the chart looks like a poorly sewn quilt. The reason for this is that much like college football teams, individual asset classes do not correlate with continued outperformance.

Now take a second to go back and look at the chart. This time I want you to focus on the gray "AA" block toward the middle of the quilt. This block signifies a well-diversified Northstar portfolio. What this block comprises is the average returns of all the various asset classes included on the quilt each year. This is the name of the game to sound investing.

At Northstar, our goal isn’t to pick the winning asset class or who will be the national champions but rather to diversify and benefit from the returns of the whole. In doing so, you’ll notice that is the only color that shows any correlation. What this means for you is a more steady and predictable range of outcomes.

Why Diversification Works

• Less Risk, More Opportunity: By spreading your investments, you reduce the risk of relying on any one asset. Even if one "team" underperforms, others in your portfolio might perform better.

• Consistency Over Time: Just like a football season, the market has its ups and downs. Diversification helps smooth out those fluctuations, helping your portfolio better withstand periods of volatility.

• Capture Surprises: Just as an underdog team could surprise everyone by winning the championship, a diversified portfolio can take advantage of unexpected growth in sectors you might not have anticipated.

The Bottom Line

In college football, there are always surprises. Teams we thought would dominate might fall flat, and underdogs can rise to the occasion. The stock market is no different. While you might think you have a favorite team (or asset class) that will win big, the reality is that performance is unpredictable.

By diversifying your portfolio—just like betting on multiple football teams—you can increase your chances of success no matter what happens throughout the season. Even if your first-choice “team” doesn’t win, you’ll still have other strong contenders in the mix, helping you stay in the game.

So, as we head into 2025, remember: Diversification is your playbook for success. Just as a great football team needs a variety of players and strategies to win the championship, a successful investment strategy requires a well-balanced portfolio to thrive over the long term.

Let’s keep our eyes on the field and ensure your investments are positioned for a successful season.