Many stories making the media rounds these days say that diversification offered little protection in 2008. First, these reports are factually incorrect. Although most asset classes performed poorly, there was one notable exception: bonds. Despite the credit crunch, the flight to safety ensured that Canadian Bonds as a whole returned 5.2% for the year. Second, even within stocks, diversification offered a measure of protection. Recall that U.S. equities lost 23.5% compared to the 33.8% loss in Canadian stocks.

Third, it is unrealistic to assume that diversification across equity markets will somehow help avoid a poor year. A cursory glance at market history would have shown that such an assumption is false. The TSX Composite, S&P 500, MSCI EAFE Index and MSCI Emerging Markets Index all lost money in 1990, 2002 and 2008. One of the lessons of the Long-Term Capital Management crisis (When Genius Failed is a good book on LTCM) is that in times of financial stress, the correlation among equity markets tends to go to 1. In other words, there will be no place to hide in stocks. It has happened before and it is almost certain to happen again and equity investors should be prepared to endure rough sailing when it does.