The Art of Staying Diversified: Lessons from History

Let me tell you a story. It’s a story about how hard it is to stay diversified, and why it’s so important.

By Kit Lancaster, Sterling Edge Financial

Let me tell you a story. It’s a story about how hard it is to stay diversified, and why it’s so important. Think of it like a dinner party discussion that starts innocently enough but ends with a surprising twist—the kind that makes you reconsider your assumptions.

Scene One: The Comfortable Echo Chamber

Imagine you’re at a barbecue. Your neighbor, Jim, is raving about his US stock portfolio. “Why bother investing internationally?” he says, flipping a burger. “US stocks are crushing it. Look at the returns since 2008.” Around the table, heads nod. Jim isn’t wrong—US stocks have outperformed globally for nearly two decades. But let’s pause here. Are we hearing wisdom, or just the drumbeat of recency bias?

Investing feels easiest when you’re following a trend that everyone around you validates. It’s human nature to stick with what’s familiar and successful. The problem is, markets don’t reward comfort for long. And this isn’t the first time investors have felt invincible.

Scene Two: A Tale of Two Markets

Let’s travel back to the 1980s, when Japan was the darling of global investing. Japanese stocks rose every year from 1983 to 1990, capturing nearly half of global market capitalization. The narrative was irresistible: Japan’s manufacturing prowess and superior management seemed unstoppable. Investors piled in. But then came the bust. For the next 35 years, Japan’s stock market delivered near-zero nominal returns.

Fast forward to today, and the US seems as indomitable as Japan once did. US companies lead the world in technology and innovation. Our venture capital ecosystem is unmatched. But let’s not forget, success often plants the seeds of overconfidence.

Today, US stocks trade at nearly three times sales and four times book value—the same inflated multiples Japan had at the height of its bubble. Meanwhile, international markets trade at much lower valuations. Historically, when one region has outperformed for an extended period, it’s often followed by a reversal. Betting heavily on a single market’s continued dominance is like assuming the sun will never set.

Scene Three: When Bonds Beat Stocks

Diversification isn’t just about holding international stocks. It’s also about balancing different asset classes—like stocks and bonds. Let’s rewind to the early 2000s, a period that offers a stark reminder of why diversification matters.

From 2000 to 2009, often called the “Lost Decade” for stocks, the S&P 500 delivered an annualized return of -1% after accounting for inflation. Investors who placed all their bets on equities saw little to no growth in their portfolios. But bonds told a different story.

During that same period, high-quality bonds, like US Treasury securities, significantly outperformed stocks. The Bloomberg US Aggregate Bond Index returned an annualized 6.3%, providing stability and positive returns when stocks faltered. For diversified investors, bonds acted as a buffer, cushioning the impact of the stock market’s poor performance. This era highlights why a portfolio heavily skewed toward one asset class can be risky—even when that asset class has historically performed well.

Scene Four: The Power of Global Diversification

Diversification isn’t sexy. It doesn’t dominate dinner-table conversations or headline news. But it’s prudent. By diversifying globally and across asset classes, you’re not betting on one country’s or one asset’s economic future—you’re betting on the world’s.

The research backs this up. A 2023 study by Cliff Asness and colleagues titled “International Diversification—Still Not Crazy After All These Years” confirmed that global diversification remains a critical strategy. While markets may move in tandem during short-term crises, over the long run, they diverge. This divergence protects against the risk of any single country’s or asset’s prolonged underperformance.

For example, in the last 15 years, US stocks outperformed due to rising valuations, not necessarily stronger fundamentals. But valuation changes are fleeting. When prices are high, future returns tend to be low. International markets, with their lower valuations, present an opportunity for higher expected returns—if investors can resist the urge to chase what’s been hot. Similarly, bonds often provide a safe harbor during periods of equity underperformance, highlighting the importance of maintaining exposure to both asset classes.

Scene Five: The Psychology of Investing

Let’s revisit Jim at the barbecue. He’s not alone in his thinking. Most investors fall victim to recency bias, buying what has recently performed well and avoiding what hasn’t. This behavior—chasing winners and fleeing losers—is the opposite of “buy low, sell high.”

History shows that chasing performance leads to poor results. In 1990, investors flocked to international stocks, only to see US stocks outperform for the next decade. In 2000, the dot-com bust saw US stocks falter while international markets thrived. And in 2008, following the financial crisis, US stocks began their current run of dominance. The pendulum always swings back, but predicting when is impossible.

The Takeaway: Diversification as Discipline

Diversification is about embracing uncertainty and preparing for the unexpected. It’s about spreading your bets and acknowledging that no single market or asset class has a monopoly on success. Staying diversified is hard because it requires going against the crowd, tuning out the noise, and sticking to a long-term plan.

At Sterling Edge Financial, we believe in the power of global and asset class diversification. It’s not always popular, and it’s rarely easy. But history shows that it’s the prudent path. So, the next time you hear Jim at the barbecue, consider sharing this story. Remind him that while the US may seem invincible today and stocks may feel like the only game in town, history has a way of surprising us. And in investing, as in life, it’s better to be prepared for the unexpected than to rely on the illusion of certainty.

Disclosure: This article is for informational purposes only and does not constitute personalized investment advice or recommendations. Tax rates and laws may vary and are subject to change. Consult a financial advisor or tax professional for guidance tailored to your situation.