Why you need something other than stocks

From the article "Bonds -Why Bother?" by Robert Arnott in the Journal of Indexes, the case for stocks in the long-run is destroyed. There are long periods where bonds have outperformed stocks. The cu rent period is a perfect example where there is no equity risk premium. But bonds have not been given their due. We usually think of bonds as a diversified and a risk reducer but certainly not a return generator. Yet, if you held bonds over the period of the great moderation until today you would have been much better off than buying a basket of stocks.

Diversification is more than just risk reduction. A mix of assets in a portfolio also provides a portfolio combination which will perform differently from an all stock portfolio under different environments. This is what diversification is supposed to mean, a return pattern that respond to different factors. Diversification is not just a low correlation as measured by the numbers. There should be a unique set of reasons for different portfolio return patterns and this is what the investor is trying to exploit when forming a portfolio with different assets.