Nonetheless, most experts still believe in the idea. "Diversification does work, but it doesn't solve all your problems," says Charles Lieberman, chief investment officer of Advisors Capital Management in Hasbrouck Heights, N.J.
Even during the financial crisis, some assets gained in value, including Treasury bonds and the dollar. Mick Heyman, an independent financial adviser in San Diego, recommends a mix of conservative blue chip stocks, Treasuries and a small amount of gold.
By following that strategy, his clients' losses in 2008 ranged from 5 percent for the most conservative investor to 20 percent for the most aggressive, compared to a 37 percent drop for the Standard & Poor's 500 index.
"I believe one lesson from the crisis is that diversification won out," Heyman says.
Subject to interpretation
Financial advisers define diversification very differently.
Louis Stanasolovich, president of Legend Financial Advisors in Pittsburgh, recommends that clients devote some money to managed futures, an investment fund that uses futures and options to go long or short in virtually any asset class.
The average managed futures limited partnership gained 26 percent in 2008, Stanasolovich says. These limited partnerships are generally available only to wealthy investors with minimum investment assets of $1 million. But now there are several managed futures mutual funds. While most of them began after the financial crisis, at least one rose during 2008: Rydex/SGI Managed Futures Strategy Fund gained 8.53 percent that year, compared to the market's 37 percent loss.
"Diversification does still work, but it works in a manner most investors aren't used to," Stanasolovich says.
That brings us to the area where experts' opinions diverge greatly -- how to create a diversified portfolio. Stanasolovich and Chris Geczy, director of the Wharton Wealth Management Initiative at the University of Pennsylvania, agree that a diversified portfolio must hold alternative assets. That could include managed futures, real estate, commodities and mutual funds that employ strategies similar to hedge funds.
Noting the old adage that investors should have 60 percent of their assets in stocks and 40 percent in bonds, Geczy says, "The new 60-40 is 60 percent traditional investments (stocks and bonds) and 40 percent really diversified, including alternative assets."
The university endowment model, which includes a hefty dosage of alternative assets, works better in the long term than a portfolio of just stocks and bonds, Stanasolovich says. But that doesn't always work. Many university endowments saw their alternative assets plummet in value during the financial crisis.