I write regularly about the disconnect between how predictable investors think markets are and how unpredictable they actually are. If I needed concrete examples to make my case, 2025 was a treasure trove. At the beginning of the year, sentiment on important issues was very different than it is today, with many twists and turns along the way.

In January, who’d have thought that the Alberta government and Ottawa would finish the year in a pipeline love-in. And that our Prime Minister, who was previously a world leader in championing sustainability for global businesses, would push harder for fossil fuels than renewables.

On a lighter note, who’d have thought three of the most dominant athletes in the world would be Canadian: swimmer Summer McIntosh, basketball player Shai Gilgeous-Alexander and hockey player Connor McDavid.

Who’d have thought MAGA would end up being MEGA, at least from a stock market point of view. European stocks are up more than 30 per cent in U.S. dollars year-to-date compared with the S&P 500 at 15 per cent. In January, U.S. exceptionalism was the topic du jour. Now the conversation is more about how U.S. policy is fuelling China’s ambitions in renewable energy, semi-conductors, electric vehicles and artificial intelligence.

Who’d have thought the stock market would be so good with such little resolution on trade issues and that Canada would be at the head of the pack. Just as surprising is that the S&P/TSX composite index did so well – up 30 per cent including dividends – without the usual stalwarts. The railroads lagged, dividend mainstays BCE Inc. and Telus Corp. had miserable years, as did perennial favourites Constellation Software Inc., Thomson Reuters Corp. and Alimentation Couche-Tard Inc. Banks, gold and natural gas led the charge.

Who’d have thought the market for initial public offerings would fail to ignite against such a perfect backdrop. The pickup in IPOs was modest despite raging animal spirits, high public valuations and the desperate need for private equity funds to sell companies.

In 2025, the consensus on AI moved around more than Patrick Mahomes in the pocket. It turned out to be the tale of two halves, with the focus shifting from a desperate need for more computing power – for training generative AI models – to a focus on the financial viability of data centres and where their power is going to come from. Companies investing aggressively in AI were rewarded in the first half and penalized in the second.

Oracle Corp. was one of those. It initially got a boost when it announced it would spend a king’s ransom on AI infrastructure, but more recently has been hammered for the same reason. CoreWeave Inc., a pure play on the data centre buildout, is down almost 60 per cent from its June high.

Conversely, Apple Inc., the anti-AI company, is finishing a great run after lagging behind hyperscalers Microsoft Corp., Meta Platforms Inc. and Amazon Inc. for most of the year. But the best AI-related performer was Alphabet, a company derided for ceding its technological leadership. It stumbled out of the gate but now has the best large language model and is by far the stock market winner.

Crypto’s year also had very different halves. Believers were euphoric about the possibilities when the crypto-friendly U.S. President was sworn in. Prices skyrocketed and bitcoin treasury companies, which never made any economic sense, multiplied like rabbits. Strategy Inc., the archetype for the category, was up more than 50 per cent by mid-July, but with bitcoin now in the red for the year, its stock is down 45 per cent since the beginning of the year.

Leading players in the sports betting epidemic, DraftKings Inc. and Flutter Entertainment Plc (which owns FanDuel), also started the year on a roll. More recently, however, they’ve been a bust as growth shifts to the prediction markets, which operate in the more regulatory-friendly environs of finance. What were the odds of that?

The biggest takeaway from 2025 for investors is to be wary of bold pronouncements and confident forecasts about what’s going to happen in 2026. Many, maybe even most, will prove to be wrong, ill-timed or temporary in nature.

I’ll end with a story from Morgan Housel of the Collaborative Fund. In one of his newsletters in 2022, he referenced the night before the D-Day invasion in 1944 when Franklin Roosevelt asked his wife Eleanor how she felt about not knowing what would happen next. She said, “To be nearly sixty years old and still rebel at uncertainty is ridiculous, isn’t it?”

I use the word “diversification”’ a lot. I know it’s basic, even boring, but I’m a believer. For over four decades, I’ve watched clients with diversified portfolios build their wealth and achieve their goals.

But the word’s meaning is more nuanced than I sometimes let on, particularly with regard to fixed income.

When I started in the 1980s, two asset types made up the secure section of portfolios – government bonds and T-bills. Today, there’s a plethora of products with different features and use cases.

All have a fixed obligation to pay interest and repay principal, but they diverge from there. In balanced portfolios, some help smooth returns, some protect against market meltdowns, and some provide no diversification at all.

Let’s look at the fixed-income tool kit through a diversification lens.

Savings vehicles

There are many options in the short-term savings category – T-bills, GICs, money market funds, and cash management products.

These are simple to understand. The yield is clearly stated and the principal holds steady, even in bear markets. In a portfolio, they help smooth out the bumps and provide ready liquidity for spending and rebalancing.

There’s a cost, however, to holding savings products in investment accounts. The yield will generally be below your required return and may not fully offset inflation.

Government bonds

Government bonds are longer-term loans (five to 30 years). Like the savings vehicles above, there’s no risk of default. You know you’ll get your money back.

But government bonds are a more valuable offset to stocks because they’re sensitive to changes in interest rates. Remember, when market yields drop to stimulate a faltering economy or deal with a crisis, the bonds you already own become more valuable. With turbulence all around, government bond prices go up (the longer the term, the more a bond responds to rate changes).

Government bonds are the place to be at crunch time, but there are trade-offs. They provide a steady income, but again, the potential return is less than most portfolios hope to achieve. And the returns can be volatile as interest rates change. They’ll be times when you wonder why you own them. That is, until they show up to save the day.

I’ve talked so far about one source of return – interest rate risk. There’s another useful tool in the kit – credit risk, or the risk that a borrower defaults on a loan.

Investment-grade bonds

Corporate bonds have credit risk and holders are compensated with higher yields versus comparable government bonds. The extra yield is called a spread. How much spread depends on the reliability of the borrower. Investment-grade borrowers such as banks, insurers, telcos and utilities are unlikely to default and therefore have a modest spread – 0.5 to 1.5 percentage points. For bonds issued by less reliable and/or cyclical borrowers, spreads range up from three percentage points.

Spread product is a valuable part of any portfolio but it complicates the diversification picture. When the economy and markets are weak, investors worry about defaults and spreads go up, which negates some of benefit derived from falling interest rates.

High-yield bonds

Riskier “high yield” bond funds have an excellent return record, in some cases rivalling equities.

One of my rules of thumb, however, is that if something has equity-like returns, it also has equity-like risk, and most likely is highly correlated with the stock market. That’s the case here.

High yield generally has shorter terms-to-maturity, which means it benefits less from rate declines. The biggest swing factor is changing sentiment towards defaults. Growing negativity can push spreads from the mid-single-digits to the low- to mid-teens. Yes, five to 10 percentage points.

High yield is great return generator but not a great diversifier. It’s technically in the fixed-income bucket but behaves more like stocks.

Private credit

Private debt funds, which hold loans that aren’t publicly traded, have been the fastest growing asset class over the past decade. As the category matures, the differences between private debt and high-yield bonds are narrowing.

There is one big difference, however – private loans usually have floating rates. The yield goes up and down with interest rates. In a falling rate environment, holders get hit by dropping yields. If spreads are also rising, these funds, like high yield, are not dependable diversifiers.

I’ve left convertible bonds, mortgages and preferred shares for another day. In the meantime, I hope you’ll assess your fixed-income holdings with a more discerning eye. Be clear on their purpose, and ask yourself whether they’re there to enhance your returns or provide downside protection.