Why Global Diversification in Investing is the Antidote in Chaos
You are an investor with goals and desires for your financial life reaching far out into the future. Unfortunately, the journey to achieving your long-term wealth goals follows a road that is not always smooth, clear and free of debris. Sometimes the market and the world at large will litter our path with obstacles for us to overcome. Global markets have been experiencing increased volatility, which comes in stark contrast to the even, steady growth that we often expect.
The market chaos does not happen on an island. The media trumpets, “This time is different.” Your world quickly changes as your investments plummet. When it comes to investing in preparation of good times and bad, what is an investor to do?
The answer is actually pretty simple: EVERYTHING!
As investors, we have to balance risk and return. It’s our desire to get as high returns as possible while also wanting to avoid the big losses.
What Does Diversification Do For You in Investing?
Diversification allows you to have the right balance between risk and return. As investors, it is important to realize that many of the companies we buy our products from on a daily basis are headquartered all over the world. We don’t limit our consumption to US products, so why would we limit investment portfolios to US companies? Instead, it makes sense to invest in many of the great companies of America and the rest of the world to maximize the potential of your portfolio.
Portfolio diversification is one of the most fundamental and important tenets of modern finance. Yet, most investors continue to turn their backs on what is called the only free lunch in modern finance and hold portfolios that are either fully or heavily weighted toward where the live.
This is why we encourage you to diversify when investing. Anything can happen at any time, with little notice.
A Tale of Two Decades: What Are the Lessons for Long-Term Investors?
Let’s look back over the last twenty years. Comparing market returns across the 2000s and 2010s only reinforces the benefits of diversification.
The first decade of the 21st century, and the second one that recently ended, have reinforced for us as investors some timeless market lessons: Returns can vary sharply from one period to another. Owning a broadly diversified portfolio can help smooth out the swings, and can increase the potential for long-term success.
Since the Great Recession of 2008-2009, US stocks have outperformed non-US stocks. As US stocks have outperformed international and emerging markets stocks over the last several years, some investors might be reconsidering the benefits of investing outside the US.
What Happened in the Lost Decade in the US?
We can examine the potential opportunity cost associated with failing to diversify globally by reflecting on the period in global markets from 2000–2009. It began with the Dot.com Bust and Ended with the Great Recession. Remember way back then?
During this period, often called the “lost decade” by US investors, the S&P 500 Index recorded its worst ever 10-year performance with a total cumulative return of –9.1%. However, looking beyond US large cap equities, conditions were more favorable for global equity investors as most equity asset classes outside the US generated positive returns over the course of the decade.
Global Index Returns
January 2000–December 2009
S&P data © 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. MSCI data © MSCI 2018, all rights reserved. Indices are not available for direct investment. Index performance does not reflect expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results.
Expanding beyond this period and looking at performance for each of the 11 decades starting in 1900 and ending in 2010, the US market outperformed the world market in five decades and underperformed in the other six.
This further reinforces why an investor pursuing the returns of equities should consider a global allocation. By holding a globally diversified portfolio, investors are positioned to capture returns wherever they occur.
There is a World of Opportunity in the World’s Equity Markets
You never know which markets will outperform from year to year. By holding a globally diversified portfolio, investors are positioned to capture returns wherever they occur.
Research shows there is no reliable way to predict top performers. Broad diversification helps reduce unnecessary idiosyncratic, individual risk.
We would like to think of the US as a world leader, but over the past several decades America has never been the number one market in with the world of annualized performance. Nobody knows what the future will bring. But if you own many companies around the world, you can worry less if any one company or even one country experiences losses. Keep in mind that international stocks can be riskier than US stocks due to currency and political risk, among other things. That is why it’s so important for you to carefully decide how to allocate your portfolio between US and international stocks.
Over long periods of time, evidence-based investors who adopt a global portfolio can enjoy the diversification benefits as well as potentially higher expected returns.
What Should Investors Do During Market Volatility?
Life is uncertain. The market is even more precarious. This means building wealth has no shortcuts. Success requires a solid investment approach, a long-term perspective, and discipline to stay the course. Instead of leaving your financial future to chance, you need to have a plan.
Cogent Strategic Wealth is here for you.
So, instead of worrying about your future, why not take positive steps to protect it? Set up a Cogent Conversation with us today. We’ll show you how to transform your hard work into durable wealth even through troubling markets.
With our years of experience, we know a disciplined investor looks beyond the concerns of today to the long-term growth potential of markets. Investors have had concerns and challenges in the past, and they know there will be concerns and challenges in the future.
We are here for one reason: to help you reach your financial goals, come what may. Contact us today so we can help you, too.
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