February 18, 2015

Don’t Give Up on Global Diversification

With the S&P 500 outperforming international stocks in four of the last five years, some investors may wonder, “why continue investing globally?”

The short answer is: diversification. Global equity returns tend to ebb and flow.  Historically, international stocks and U.S. stocks have both had extended periods of outperformance. International stocks had a particularly good run in the 2000s: the MSCI ACWI ex-U.S. Index outperformed the S&P for six straight years —2002 through 2007. Over that period, the MSCI Index had a cumulative return of 150% compared to the S&P’s 42%. However, had an investor been drawn go all international at the end of 2007, they would not have fared well — the MSCI Index has lost 4% since 2007 and the S&P has returned 63%.

Unfortunately, timing the inflection points is notoriously difficult. Staying diversified, rebalancing, and remaining invested in out-of-favor segments of the market can improve long-term returns.

Human nature, however, can lead us to do the opposite and gravitate to what has outperformed recently. This is why an investment policy statement is a great tool and guide for maintaining a long-term perspective and keeping behavioral biases in check.

Global diversification chart