By Kostya Etus, CFA, Senior Portfolio Manager
A more stable experience
Diversifying across multiple asset classes, such as U.S. stocks, international stocks, and bonds, has historically provided better and more stable returns than investing in one asset class alone. By investing in a globally diversified, balanced portfolio, we believe investors may reduce their risk and experience smoother returns over time— helping them stay invested through market ups and downs, and ultimately providing greater chances to reach long-term financial goals.
Since the 2008 financial crisis, U.S. stocks have experienced one of the longest and strongest bull markets in history while international stocks underperformed, driving many investors to rethink their diversification strategy. This “fear of missing out” mentality — the thought that by staying invested in one investment, you will sacrifice better returns in another — has prompted some investors to overweight high-performing allocations.
But if history is any guide, no one asset class consistently stays on top for too long. Staying invested over the long-term is how diversification earns its keep. Since 2000, a period that includes both the tech bubble and the financial crisis, globally diversified, balanced portfolios outperformed all U.S. stock portfolios and did so with much lower risk. We believe this is further evidence that investing in a globally diversified, balanced portfolio makes sense for investors, perhaps now more than ever.
Finding a Balance
By investing in a diversified portfolio, investors not only tend to stay invested longer by eliminating short-term market noise, but also decrease the risk of single-asset-class investments.
For example, an investor investing in only financial stocks during the financial crisis of 2008 would have resulted in heavy losses. But by increasing the variety of positions in a portfolio, investors reduce the risk of overweighting their portfolio to one investment or asset class.
The accompanying chart lists the performance of individual asset classes every year since 2000. As you can see, an asset such as emerging markets (light blue) can have extreme highs and lows from year to year compared to the much smoother returns of a global, balanced portfolio (grey). We believe that having exposure to a variety of asset classes limits the negative impact of underperforming allocations while providing more stable returns helping to keep you invested for the long term.
Saving Us from Ourselves
Many investors understand the negative effects of buying high and selling low. But in times of market uncertainty, emotions can make irrational decisions seem rational. A natural human tendency is to buy at market peaks when things are good and sell during market troughs when fear is high.
To quantify the human nature effect, let’s evaluate the difference between investor-driven returns and the actual returns of an investment. That difference between these two performance figures is known as the “behavior gap” (the cost associated with human behavior). A recent study by Dalbar, an independent research firm, showed investors lost about 3.6% in average annual returns between 2007 and 2017 because of their behavioral biases and emotion-based investment mistakes.
It seems that no matter what people are investing in, they need to be saved from themselves. This is where we believe globally diversified, balanced portfolios come to the rescue.