The Importance of Diversification for Individual Investors
Most investors understand the benefits of diversification. Few individuals think it wise to hold just a few stocks or invest heavily in just one sector. Diversifying is central to risk management and is vital to long-term investment success.
Yet most American investors aren't nearly as well diversified as they think. American investors tend to focus on US stocks only. But US-only investors can miss huge opportunities to manage risk and enhance performance. The US is only about 50% of the world's developed equity market!
US-Only Investors Miss Half the Picture
Imagine investing in only half of the S&P 500 sectors. Consumer Staples, but not Health Care. Tech, but not Energy. What if you picked the worst sectors and missed the best? In the same way, a US-only portfolio can also be risky—it can lack the opportunities for both performance enhancement and risk management that you could get in a global portfolio.
*Pacific includes four developed market countries: Australia, Hong Kong, New Zealand and Singapore.
**Europe and Middle East includes 15 developed market countries: Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Israel, Italy, the Netherlands, Norway, Portugal, Spain, Sweden and Switzerland.
Source: FactSet. The portfolio shown above reflects the MSCI World Index as of 06/30/2015. The MSCI World Index measures the performance of selected stocks in 23 developed countries. Values may not sum to 100% due to rounding.
Opportunities Abound Abroad
Many American investors focus solely on US stocks, either because they don't have the individual expertise to analyze foreign stocks, or because they believe the US affords enough performance opportunities. While it's true America is still the world's largest single economy and market, performance is cyclical and leadership in capital markets changes all the time.
The following table shows US stock market performance along with the return of the best performing countries in each year. Over the past 10 years, the US has been in the top-five performing developed stock markets only four times.
Annual Equity Return by Country
*Source: FactSet, as of 1/5/2015. The above returns reflect the Total Returns of the top 5 performers of the 23 developed countries that comprise the MSCI World Index, from 12/31/1994 – 12/31/2014. All returns are presented in USD. All returns are net of international withholding taxes, except for US returns, which are gross, and Israel’s returns prior to 2001, which are gross due to data availability.
Leadership Keeps Changing
Also, look at the top five nations each year. There's little consistency—each year's best performers rarely maintain leadership. By failing to invest in a variety of global markets, investors can miss huge opportunities.
But investing globally doesn't just increase performance opportunities, it can also enhance risk management. Because US and foreign markets don't move in lockstep, global investing can actually decrease risk characteristics. Finance theory says blending two dissimilar categories can increase return and reduce risk, and the same holds true for combining US and foreign stocks.
Investments in foreign securities can involve additional risks such as losses related to other currencies and securities markets.