Risk mitigation through diversification across time and space are fundamental tenets of conventional financial theory.
In other words, the idea is that stocks are safe in the long-run and risk or volatility can be reduced by owning assets in uncorrelated markets.
The problem is that stocks are not necessarily “safe” over any time horizon and correlations between asset classes tend to increase dramatically during times of market distress such as the past year and a half.
Target date funds are a great example. Premised on asset allocation principles, many of these funds have experienced losses over the past year that are well in excess of what would be assumed based on theory.
The Wall Street Journal just ran a fascinating article investigating the apparent failure of the “fail safe” strategy of asset allocation.
There is a great chart at the bottom of the article showing the correlation between several asset classes and the S&P 500 since 1973. Results are shown in markets that are either up or down 5% or more. In each instance, levels of correlation tend to go through the roof in down markets.
Source: Wall Street Journal (subscription required)
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