The S&P 500 has been on something of a tear. Total returns so far this year (as of Dec. 23), have been 26 per cent. That’s on top of total returns of 26 per cent in 2023.

This is the kind of investment performance that can make some investors wonder whether Warren Buffet was right when he suggested that, for most people, the best thing to do is own the S&P 500 index.

Whether this is the right investment strategy for an investor is something they would need to decide. This is in no way meant to challenge Buffet’s investment perspective. Or, for that matter, to suggest an alternative strategy for individual investors.

But recency bias can be powerful. So, with the S&P 500 up as much as it has been over the past few years, it is a good time to recall why a strategy that involves only investing in that index would require real patience and conviction at times, and why many investors stick with much more diversified strategies.

The S&P 500 has been a great long-term investment: $1,000 invested there 50 years ago would be worth approximately $360,000 today. That beats a 60/40 portfolio made up of the S&P 500 and 10-year U.S. Treasury bonds, which would have only grown to approximately $136,000 over that same period. And it beats an investment in other developed markets, such as the MSCI EAFE (Europe, Australasia and the Far East), which would have only grown to approximately $60,000.

However, a lot can get lost in long-term performance numbers, specifically the episodic and very large drawdowns the S&P 500 has experienced, and its underperformance relative to more balanced portfolios and other markets over a number of multi-year periods.

For example, investors who had 100 per cent of their portfolio invested in the S&P 500 in September 2000 would have lost 45 per cent over the following two years, about twice that of an investor in a 60/40 portfolio. It would have then taken the 100 per cent S&P 500 investor more than six years to recover their losses and almost 20 years to catch up to the 60/40 investor.

This was not the only period of S&P 500 underperformance relative to a 60/40 portfolio: In the late 1970s, it had more than three years of worse performance; in the early 1980s, it had about six years of worse performance; and in the late 1980s, it had more than seven years of worse performance.

Today, investing in the market cap (as opposed to equal weighted) version of the S&P 500 index involves a big bet on the continued strong performance of a small number of companies. The last time the Top 10 companies in the S&P 500 represented as large a percentage of the index as they do today (36 per cent) was in 1964. None of the Top 10 companies in 1964 are in the Top 10 today. In fact, three went bankrupt (General Motors Co., Sears Holdings Corp. and Eastman Kodak Co.) and two merged into other companies (Gulf Oil Corp. and Texaco Inc).

It is also important to remember that, while the U.S. public equity markets have been a good investment over the past 50 years, non-U.S. public equity markets have generated better returns over various multi-year periods. For example, between 1985 and 1989, the S&P 500 underperformed the MSCI EAFA (Europe, Australasia and Far East) index by 13.82 per cent a year, on average. And the S&P 500 again underperformed that index between 2000 and 2009 by 2.65 per cent a year, on average.

For all of these reasons, an all-S&P 500 investment strategy would, at times, require real psychological stamina on the part of individual investors. For many institutional investors, an all-S&P 500 strategy could result in drawdowns and periods of underperformance that would be hard to manage when more balanced, less volatile, strategies are possible.

Many institutional investors are not trying to generate the highest returns possible over the short term. They are trying to generate long-term, stable returns to cover a specific liability (such as pension obligations), while minimizing return volatility. Significant near-term return volatility can be hard to manage and require increased contributions. And this can result in intergenerational unfairness if those contributing need to pay more than prior generations because the fund was invested in a strategy that was unnecessarily concentrated and risky.

This is why, despite the extremely strong performance of the S&P 500, many investors still opt for more diversified investment strategies, combining non-U.S. assets, as well as government bonds, credit, real estate, infrastructure and public and private asset classes. And at times like these, with the S&P 500 continuing to generate outstanding returns, it is good to remember why.

Bert Clark is President and CEO of the Investment Management Corporation of Ontario (IMCO), an institutional investor managing $77.4-billion in assets for Ontario public funds.

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