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When building the right portfolio for your goals, you know that it’s important to diversify or, in other words, not to put all your eggs in one basket.

However, that doesn’t mean a diversified portfolio always feels good. As a matter of fact, I’d say a diversified portfolio never really feels good.

For example, if you see the stock market rising, you may ask yourself, “Why isn’t my portfolio up as much?” And when the market goes down, you may be upset that you lost money. Even if your portfolio held up better than the market, it just doesn’t feel good.

At BlackRock, we call this S&P Envy.

Let’s look at how this played the last 20 years:

During the tech bubble in 2000 through 2002, the S&P 500 dropped about 40%. The diversified portfolio shown here lost money too, but less than half as much. Still, losses hurt – both your wallet and, more importantly, psychologically.

After the downturn, as expected, the market roared back, and the diversified portfolio rose too. But, like in the downturn, not by as much. This is where that “Envy” aspect really comes into play – the diversified portfolio didn’t “keep up”.

You can see this pattern in each bull and bear market. In each rising market, it feels like diversification’s working too well by dampening gains and, in each falling market, it feels like diversification’s not working well enough, allowing losses to creep in.

Yet these same characteristics that hurt on each rise and fall are what can help diversification win across market cycles.

In this example, even though it felt like the portfolio was always losing, it actually outperformed over the long-term. Remember: emotions are short-term feelings, but they can cause us to lose our long-term perspective.

Most investors know that a well-diversified portfolio is key to long-term investing success. But not all investors understand why. In fact, it might surprise you to learn that a portfolio’s ability to achieve strong long-term returns often has more to do with how well it withstands downturns in the market than how it performs during upswings.

You can see in the chart on the left that over the last couple of market cycles, the S&P 500 has had large bull markets but also large, profound downturns.

If you’re like most investors, those downturns can be hard to stomach. Which is why the chart on the right shows a lower volatility portfolio with a downside capture of about 57. “Downside capture” is how well the portfolio performs during negative performance of the benchmark. To use an even number, for example, a downside capture of 50 means that if your benchmark, let’s say the S&P 500 in this situation, returned -10%, your portfolio would return -5%.

A lower volatility portfolio usually doesn’t have as much octane on the upside, so we assumed an upside capture of about 57 as well. Remember, an “upside capture” is just like a downside capture but for positive performing time periods.

If we compare this hypothetical portfolio with the S&P 500, we can see the power of “losing less” by having a lower downside capture in action. Since 2007, this portfolio grew more than the market despite capturing only about half of the positive returns of the market. The key reason: the portfolio didn’t lose as much, so it didn’t have to work as hard in the upturns to recoup its losses. As we like to say, roughly half of the up and half of the down got you all the up with only half of the down.

The magic is in the math. When you have a relatively small loss, like 10%, bouncing back only takes a bit more positive return that the downturn itself. In this case, about 11%. But as the losses get larger, such as 50% percent, you need a much higher return to break even. In this case, about double the loss. Understanding this math is key to understanding why a portfolio designed to reduce the downside may better suit your needs without sacrificing your goals.

Sometimes what poses the biggest risk to achieving your long-term goals is your emotions. This is especially common during large fluctuations in the market but can also happen during ordinary market cycles.

The further the market goes up, the easier it is to believe it’s going to go up forever, which can lead to buying near the top of the market. On the other hand, the lower the market falls, the more fearful you may become of losing more money, which can lead to selling near the bottom of the market.

Following this pattern is called “herding”. When the market is high, it’s because many other people have already bought in – which is why buying in would be considered “following the herd”. When the market is low, it’s because many other people have already sold.

As you might have guessed from the title of this piece, “following the herd” often backfires over the long-term.

As you can see in this chart, doing what everyone else is doing (represented by the orange bar) produced significantly smaller average returns than going against the herd, or even the market average itself. That’s why it’s really important to make your decisions based on your plan and convictions, not on market trends.

In the words of the great investor Warren Buffet, “Be fearful when others are greedy, and greedy when others are fearful.” But also remember, time in the market almost always trumps timing of the market.