Over the past year, I had the joy of having my 14-year-old son as my COVID-induced office mate. Every day as I was working, I would overhear his teachers as they did their best to keep kids engaged in their online learning environment. Little did I know that while I was eavesdropping on his conversations, he was eavesdropping on mine as well. It turns out, he learned a lot apparently. Over the summer he “arbitraged” donuts during a swim meet and he began to evaluate his spending patterns in terms of “durable” vs “consumable” goods. I realized one day however that his views on diversification were drastically different from mine and matched many of my clients. One day he turned to me and asked “Dad, instead of diversifying why don’t you just buy the winners?” Good question! Why diversify instead of just picking the “winners”?
For most of the last decade, Americans have benefited from investing in the US stock market. Instead of having a globally diversified portfolio, they have been able to simply purchase shares of S&P Index Funds and do very well. In fact, from 2009 – 2019 the S&P 500 Index returned 351% compared to a “Diversified” portfolio return of only 195.3%. Many investors have been “disappointed” by the returns from their diversified portfolio over the past 20 years. A close examination of the data below may help us understand why.
To begin, I constructed a Diversified Portfolio to compare to returns generated by S&P 500 over the past 20 years. The portfolio consisted of the S&P 500, the MSCI EAFE Index, the Russell 2000 Index, the FTSE Emerging Stock Index, and several bond indexes. These were combined to construct a “diversified portfolio.” What you see below is evidence that a diversified portfolio has had a higher return over the past twenty years even though any investor might always have felt as if they were “losing” to the S&P 500.
Over each highlighted period of time, an investor would have had a legitimate reason to have doubted whether the diversified portfolio was working. However, over long periods of time we find that the diversified portfolio would have outperformed a US-only S&P 500. The reality is that it was not that long ago (12/2009) that the S&P experienced a negative (-1.38) return over an entire decade.
There are many decades where a US-based home-biased investor has done better than they would have done if they had been globally diversified. However, there have also been many decades where a US-based home-biased investor would not have performed as well as the globally diversified investor. The reality is that while the last 10 years have been superior for US-based investors, nobody can be certain that the next 10 years will be a repeat of this performance.