What’s the best case I’ve ever heard for diversifying your investment portfolio and not putting everything in US stocks?
I wish I could say it’s something I came up with. But it’s not. It came from Dimensional’s Joel Hefner, and he’s repeated it a few times in recent years on his Matrix Book webcasts.First, the dilemma…
When you look up the long-term returns of a smartly constructed, globally-diversified index portfolio, you naturally expect to see a big return premium over a simple U.S. stock index.
Except you don’t.
From 1985-2024, the all-equity (100/0) Dimensional Core Plus Allocation Index returned +11.6%/yr. Pretty good. But the Russell 3000 US Total Market Index did exactly the same. Volatility? Exactly the same.
So why are advisors like me continuing to preach the advice of spreading your investments out globally and over-emphasizing smaller value and higher profitability companies as well? You could just “VTI and chill” as the Bogleheads say.
Joel’s brilliant observation is this: 40 years is a long time; are you sure you would have held on to a U.S.-only allocation continuously? What if you started at a different time within those 40yrs?
Sure, there were periods of US stock underperformance over this period (most notably the 2000-2009 “lost decade”). But most investors have the hardest time sticking with a portfolio that loses $.
Annual losses are hard. Three-year losses are really hard. Five-year losses? Almost impossible for the average investor to endure. 8-10yrs? Yeah, right; you’d be long gone.
And it is here where a U.S.-only allocation flops.
The Dimensional Matrix Book in Joel’s presentation reports that if you invested in the U.S. stock index at any point over the last 40 years, you would have had a negative return:
*4 times over five year-year periods
*1 time over a seven-year period
*1 time over an eight-year period, and
*2 times over ten-year periods
So 8x in 40 years, or 20% of the time, you invested into US equities and had nothing to show for it five to ten years later. It’s hard to imagine anyone sticking around after that kind of disappointment.
What happens if we look at the diversified Dimensional Core Plus Allocation Index thru the same lens? How many intermediate and long periods—five to ten years—of negative returns did it have?
Zero.
And there we have it. The benefit of diversification finally emerges.
The Dimensional Core Plus Allocation Index wasn’t noticeably better over this period from a total return standpoint vs a U.S. stock index. But it was more consistent, as you’d expect from a more balanced allocation. And more consistency is easier to stick with, increasing the odds you actually earn the returns your portfolio achieves.
That’s why I love Joel’s point, it seals the deal for me on diversification. The best investment portfolio for you is the one you’ll stick with. That portfolio is always broadly diversified.