“If you can predict the future, you shouldn’t worry about being diversified” – Greg Carlson, CCM CEO and Co-Founder
Diversification has many benefits for investors when utilized appropriately. A diversified portfolio can have lower volatility, higher returns and increase the probability of a successful retirement. Because portfolio diversification is so universally accepted and often coined as ‘the only free lunch in investing,’ people frequently assume that it will only have a positive impact on their portfolio. However, as time goes on, maintaining diversification can actually be quite frustrating. After all, diversification often means leaning into the wind and going against the crowd. A routinely balanced diversified portfolio will sell off some equities to purchase fixed income as markets rally. It will do the opposite during periods of market volatility, as bonds will be sold off to purchase equities at lower prices. Quite often this is counter-intuitive to investors ‘in the moment,’ as they want to keep buying equities as they perform well and might become scared of buying more equities after a period of market volatility.
We are currently in a frustrating time for investors who hold diversified equity portfolios because the U.S. stock market continues to outperform international markets. Since the market bottom in March of 2009, the S&P 500 has outperformed the MSCI EAFE international index by a wide margin. This outperformance seems never ending and as investors grow more frustrated, the desire to abandon the diversified approach may grow. However, we know that this is precisely the wrong time to abandon this approach. Like selling out of equities in early 2009 to move into a safe investment, the urge is strongest at the worst possible moment.
Vanguard has an excellent comprehensive analysis on international investing which reviews the many benefits of adding international equities to a portfolio. There have been many times in the past where the U.S. has been the top performer, but there have been just as many where international markets have outperformed. Unless we have a way of predicting which will outperform in the future, a diversified approach will remain the best strategy moving forward.