International Diversification Pays Off in 2015

It’s hard to believe that just six years ago we experienced one of the worst global economic and stock market meltdowns in history. However, since then stocks have experienced a meteoric rise. U.S. stocks have been dominating the recovery and have outpaced International stocks’ growth rate by nearly double, as illustrated below:

S&P 500: U.S. Large Stocks   iShares MSCI EAFE: International Stocks   iShares MSCI EM Mkts: Emerging Markets Stocks 

Glancing at a chart like this, it’s easy to see why investors have become frustrated with international stocks and diversification outside the U.S. In hindsight, it would have been great to have all your investable eggs in one basket. But we don’t have the luxury of hindsight in the real world of investing.

So far, in 2015, we have seen a reversal of U.S. stocks’ dominance. You can see from the chart below that International stocks have outperformed U.S. stocks significantly this year. In the chart below, the performance of the different stock indices from 2014 is included in the first column to illustrate how different the environment is in 2015.

Granted, this is a short time frame, but it does provide insight into why we create globally diversified portfolios. We have no way to be certain what asset class (or country) will perform well, year over year.

What we do know, however, is that the relationship between U.S. stocks and International stocks tends to be cyclical. We’ll experience long runs, like the last six years, where U.S. stocks will dominate. On the flip side, there will be times when International stocks outperform (2000 – 2009).

It’s natural for Americans to have a “home bias” in their portfolios; that is, investing all of their assets in U.S. stocks. But, we live in a 24/7 global economy and cannot forget that 70% of the world’s stock market capitalization lies outside the U.S.

Clearly, if we avoided International stocks we’d be missing out on a lot of action. We have International exposure in all of our portfolios and, typically, we allocate around 1/3 of the equity portion to International Stocks.

You could certainly argue for a bigger allocation outside the U.S., considering the global landscape, but we see no reason to change our strategy. We still believe that the U.S. is the strongest economy in the world, and will continue to be.

However, if we completely left International stocks out of our portfolios it could prove to be a costly mistake over the long-term.