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Should You Have Invested, All Your Money in India in 2014?

Peering out into the investment world on January 1, 2014, Ms. X decides to put the bulk of her portfolio in a mutual fund investing in India. Mr. Y, on the other hand, chooses to put a significant amount of his assets in Latin American stocks. As it turns out, the average stock fund investing in India gained 44.6% in 2014 while the average Latin American fund lost 12.9% (according to Morningstar).

Who made the better choice? The answer appears to be Ms. X, who achieved incredible returns by selecting India. I would argue that neither Ms. X nor Mr. Y acted in a particularly wise manner. They both made big bets with an outcome that was far from certain.

Avoiding large, speculative wagers is one of the main reasons for diversifying your portfolio among different types of investments. Diversification will, however, necessarily cause you to under-perform the best performing asset classes or sectors in any given year. It will also allow you to avoid the biggest losses. Over time, diversification can lead to solid returns with fewer ups and downs.

It wasn't clear whether stocks were going to be successful in 2014 after the solid gains in 2013. The S&P 500 Index ended up performing almost twice as well as the expectations of Wall Street strategists at the beginning of 2014. But not all stocks are the same.

For better or worse, many people use the S&P 500, dominated by the largest, publicly-traded U.S. companies, as the basis for determining how investments should be performing. Yet, a broader universe of investments exists beyond large U.S. companies. Mid-size U.S. companies achieved good results, but around 4% less than large-cap stocks. Small-cap stocks were up even less than their counter-parts. Then there were foreign stocks. They were down almost 5% as a whole. Exposure to mid-cap, small-cap, and foreign stocks lowered the returns of a diversified portfolio as compared to the S&P 500. In other years, the S&P 500 lags these types of equities.

Elsewhere, real estate and utilities provided solid returns whereas energy and precious metals were down sharply. Energy was a big surprise as it was the darling of much 2014 until we experienced a dramatic decline in the price of oil at the end of the year. (You probably didn't see that one coming either.)

Bonds defied expectations as well. 2014 began with 10 Year Treasuries yielding 3.03%. With a gradually improving economy and declining unemployment, it looked like interest rates were poised to rise, which means that bonds were likely to perform poorly. Instead, interest rates stayed low and the 10 Year Treasuries closed the year with a 2.17% yield. This meant that bonds had another decent year. Being defensive with respect to bonds didn't pan out. It may (or may not) prove a good strategy in 2015.

Ultimately, your investments should be postured to meet your financial needs at an acceptable level of risk. Attempting to make the most money possible is wonderful if it works; for example, going all-in on India in 2014. But such an approach can potentially lead to perilous results.