As an investor, it’s natural to be drawn to invest in your “home” market. The United States is where you live and work. You know the companies, politics, and economic climate. It also doesn’t hurt that the returns of the U.S. market have been fantastic over the last decade. From 2010-2022 the S&P 500 has returned an average of 12% annually.
In comparison, over the same period, the MSCI All Country ex US index, representing global stocks excluding the US, returned an average of 3.5% annually. These figures might lead one to question the need for global diversification. I’m here to convince you that diversification is, in fact, “the only free lunch” in investing.
History has demonstrated the importance of looking beyond recent performance and that any country, even successfully developed ones, can have long periods of sustained underperformance.
For example, let’s start by looking at the United States for the decade directly before the one mentioned above. From 2000-2009, known as “the lost decade,” the S&P500 had an annualized return of -1%, while the MSCI World ex US index had an annualized return of 1.6%. Over this decade, investors lost money by investing in the US stock market and had 27% less money than an investor who invested in global ex-US equities.
Another example is Japan. In 1989, Japan held the title of the world’s largest stock market. With a total market cap of approximately $4 trillion USD, iconic companies like Toyota, Sony, and Honda were global industry leaders. Japan had a diversified economy and was widely regarded as the world’s technology hub. During the 1980s, the Japanese market grew from $0.5 trillion to $4 trillion, with the Nikkei (Japan’s equivalent of the S&P 500) delivering impressive annual returns of 19.5% from 1980 to 1989. At that time, the US stock market’s size was smaller than that of Japan at around $3 trillion.
However, fast forward 35 years, and the picture looks starkly different. Today, the US market is valued at a staggering $40 trillion, while the Japanese market lags behind at approximately $5 trillion USD. Notably, Japan experienced no runaway inflation, wars, political turmoil, social unrest, or famine during this period. Despite its once fast-growing market and technological prominence, the Nikkei grew by less than 1% annually over the next 35 years. This is a powerful reminder that even the most promising markets can encounter prolonged stagnation.
The tale of Japan’s rise and subsequent stagnation highlights the importance of global diversification. While recent US market returns have been remarkable, investors must consider the broader global landscape and the potential risks of concentrating investments solely in one country. By embracing global diversification, investors manage risk, gain exposure to diverse opportunities, and position themselves to capture long-term growth potential. A well-diversified portfolio provides resilience, protects against overexposure to a single market, and helps navigate the uncertainties of the global economy.
This information is educational and does not intend to make an offer for the sale of any specific securities, investments, or strategies. Returns and market information quoted here was pulled from publicly-available, third-party sources believed to be accurate. Investments involve risk and, past performance is not indicative of future performance. Any actual return will be reduced by advisory fees and any other expenses incurred in the management of a client’s account. Consult with a qualified financial adviser before implementing any investment strategy.
This year, I’m grateful for Diversification. Diversification is the only free lunch in investing. Let me repeat that. Diversification is the only free lunch in investing. As an investor, it allows you to dramatically reduce the range of possible outcomes in your investment portfolio, thereby making it easier to reach your financial goals. The range of performance of individual US companies this year was extremely wide and volatile. Think of it as a roller coaster with huge and frequent ups and downs. By diversifying, you were able to avoid some possible very negative outcomes. The video below provides a nice visual of the performance of the S&P500 year-to-date and gives an example of how increasing diversification, in this case by adding in small-cap companies, can help smooth the ride.
Video created by Jan Varsava.
My excitement about investing led me to pursue a role as a stockbroker in Philadelphia right after I completed my MBA. Back in the late 1960s, almost no one bought mutual funds. As a broker, I made recommendations to my clients about which stocks to buy. Then, the trend was to bet big on the next ‘winner’ – not too dissimilar from today’s speculation around cryptocurrency.
As a young broker, I had worked hard to save $3,000. I was ready to invest my money the same way I invested my client’s money. I looked over the recommended stocks list, researched, and narrowed my options down to two companies. One was a mobile home company, and the other was an airline that delivered oil drilling equipment to Alaska’s north slope.
Both stocks were selling at $30 a share. With my $3,000, I could buy a full lot (100 shares) of either one. The airline stock had a more exciting story, so I bought that one.
I watched both stocks closely over the next several months. Unfortunately, the airline stock took a severe nosedive, falling to $3 a share, a whopping 90% loss, while the mobile home stock doubled to $60 a share. After many agonizing days, weeks, and months, I sold my airline investment for $300, suffering a loss of $2,700.
With my annual salary of $9,000, my finances took a significant hit. I just blew up my nest egg! I kicked myself for not buying the mobile home stock and earning $6,000 – a net difference of $5,700! That much money could have changed my life. I could have bought a nice car, taken a European vacation, or used the money for other exciting adventures. Regret reigned supreme. Mainly I questioned why I didn’t split my investment by buying 50 shares of each company – at least then I would have spread out my risk.
Lesson Learned: Diversification can help you get better results with less stress.
Diversification is a way to spread your risk, increasing the chances of your exposure to potential winners; a way to own the haystack rather than searching for the needles. Also, different countries and sectors perform differently at different times – it’s almost impossible to predict when each will have its day in the sun. If you are deeply diversified, you increase your chance of owning the winners, and at the right time.
Back then, I would have told you I was investing. With the wisdom that comes with age, I now know that I was gambling. Why? I put all my eggs in one basket by betting on one company. Also, even though the insight helped me learn my lesson, I would never call buying two stocks proper diversification. Today, our clients have access to expertly-designed mutual funds that make it easy to own around 13,000 stocks from around the globe. A strategy that is much better than betting on one airline!
I was lucky to learn early on that – both financially and emotionally – diversification deserves a key place in any long-term investment strategy. No one can accurately predict which investments will win and which will lose, and take it from me, you can drive yourself crazy watching to see whether your bets are going to pay off.
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