Why a globally-diversified portfolio can help you weather the short-term ups and downs of investing
Nobel Prize-winning economist Harry Markowitz famously called diversification the only “free lunch” in finance. And it’s hard to argue the logic that a diversified portfolio can deliver improved performance and lessened risk relative to individual asset classes.
But when it comes to international exposure, many investors tend to forget every lesson they’ve learned about spreading their eggs across many baskets. U.S. investors hold an average of 15 percent of their stock portfolios in foreign companies. While some believe the extra costs and volatility that can accompany foreign stocks and bonds supports this less-is-more approach, others insist a globally diversified portfolio puts investors in the best position to weather market gyrations and deliver a more stable set of returns over time.
Investing in a single region leads to higher risk
Since the bull market emerged in 2009, U.S. stocks have outperformed international stocks overall, causing some investors to question the benefits of global diversification. Their skepticism is understandable: world events are unpredictable, and everything from trade friction to currency movement to political unrest influences market swings.
“Home bias” is another factor; people prefer to invest in what they feel comfortable with. For instance, the average U.S. investor is more familiar with Facebook than Tencent, China’s social media conglomerate that holds a similar market value.
But here’s the thing: it’s nearly impossible to avoid international exposure in today’s global economy, and nearly half the revenues of many U.S. companies in the S&P 500 Index come from overseas. Furthermore, while there have been many years in which U.S. investments have outperformed their international counterparts, there are many others in which international vehicles have come out on top.
For example, while both U.S. and international large cap values took massive hits in 2008 as a result of the financial crisis—minus 36.5% and minus 44.3%, respectively—international large caps bounced back stronger the following year, posting a 37.2% increase in value vs. a domestic gain of 19.7%. And in 2017, U.S. small cap value increased by 14.6%, whereas international small caps gained 28.6% in value.
In fact, the Dimensional Equity Balanced Strategy Index— which is comprised of a range of equity indices split between 70% U.S. and 30% non-U.S. securities—has outperformed the S&P 500 Index in 80% of overlapping 10-year periods:
Past performance does not guarantee future results.
The average return of a mix of U.S. and international investments makes it clear that long-term investors will benefit from holding both. And global diversification helps reduce the concentration risk of investing in a single region, offering potentially smoother sailing over time.
3 reasons to consider globally-diversifying your portfolio
- A world of investment opportunities. Half of the world’s market cap is located in companies outside the U.S. and excluding them from your investment portfolio drastically limits your investment opportunities. That’s not to say foreign companies are better than domestic ones, or vice versa. But since U.S. and international stock markets don’t exactly move in lockstep with each other, holding a well-diversified global stock portfolio over the long-term can improve returns and reduce risk.
- Minimize risk. There’s good reason the early 2000s is referred to as the “Lost Decade:” Between 2000 and 2009, the S&P 500 Index recorded its worst 10-year performance ever, with a total cumulative return of -9.1 percent. But for many investors who maintained globally-diversified portfolios, the Lost Decade wasn’t really lost at all.
Most equity asset classes outside the U.S. had positive returns over that same period, with the MSCI Emerging Markets Index reporting a total cumulative return of a whopping 154.28 percent and MSCI World ex USA Index reporting a total cumulative return of 17.47 percent. Clearly, a broadly-diversified global portfolio can help moderate declines during periods of volatility in certain parts of the world, while delivering competitive risk-adjusted returns.
- Think big picture. There’s no denying that the U.S. market has outperformed the world market in recent years. But savvy investors realize that’s only part of the story. Over the past 11 decades, the U.S. market has beat the world market in five, and the world market performed better in the other six. At the end of the day, there is no predicting the extent to which one area of investment will outperform the other – and investing in both is a good strategy to minimize risk.
Diversification of geography, not just investment vehicle
Investing a single country can expose investors to unnecessary risk. Spreading investments across a globally-diversified portfolio enables you to invest in foreign companies that have different characteristics and economic drivers than U.S. companies, creating the potential to capture the returns of diverse markets while moderating the short-term ups and downs of investing.
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