Why Should You Diversify?

When international stock returns lag, investors may feel tempted to double down on their home market. Historical data suggests the long-term benefits of diversifying globally.

With US stocks outperforming non-US stocks in recent years, some investors have again turned their attention toward the role that global diversification plays in their portfolios. In the five-year period ending March 31, 2020, the S&P 500 Index had an annualized return of 6.73%, while the S&P Developed Ex-US BMI (broad market index) lost 0.05% and the S&P Emerging BMI added 0.07%.

While there may be reasons why US-based investors would prefer a degree of home bias in their equity allocation, using return differences over a relatively short period as the sole input into this decision may result in missing opportunities that the global markets offer. It is important to remember that:

1) Non-US stocks help provide valuable diversification benefits.

2) Recent performance is not a reliable indicator of future returns.

There’s a World of Opportunity in Equities

The global equity market is large and represents a world of investment opportunities. As shown in Exhibit 1, nearly half of the investment opportunities in global equity markets lie outside the US. Non-US stocks, including developed and emerging markets, account for 46% of world market capitalization1 and represent thousands of companies in countries all over the world. A portfolio investing solely within the US would not capture the performance of those markets.

The Lost Decade

Recent history provides us with a valuable lesson on the importance of diversifying globally. The period from January 2000 to December 2009 is often called the “lost decade” by US investors, as the S&P 500 Index recorded one of its worst 10-year performances with a total cumulative return of    –9.1%. However, looking beyond US equities, conditions were more favorable for global equity investors as major indexes outside the US generated positive returns over the course of the decade (see Exhibit 2.)

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Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

Indices are not available for direct investment. Their performance does not reflect ...

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