Not All Markets Have Recovered From the Financial Crisis

I have been seeing a lot written like the above about how investors should globally diversify. However, global diversification can be a big mistake. During 2006-07, equity mutual funds focused on developed international markets and emerging markets provided strong relative returns to U.S. stocks. During that period, U.S. investors made net purchases of $285 billion in mutual funds investing in non-U.S. stocks, and liquidated on balance some $35 billion from funds focused on U.S. stocks. This occurred because, like now, it was touted by fund marketers as adding “non-correlated assets,” or “reducing volatility risk.” In 2008 — with non-U.S. developed market funds falling by 45% and emerging market funds tumbling by 55%, we learned once again that, just when we need it the most, international diversification lets us down. Global diversification provided neither superior returns, nor reduced volatility, versus investing in a broadly diversified US index fund (such as SPY or VTI).

Some articles argue that because international markets have largely underperformed since 2009 that now is the time to invest in them. This smacks of market timing, which scholarly studies have shown consistently results in poor investment results.

It is also worthwhile noting that the average investor has some knowledge of what is happening in the US economically, but knows much less regarding what is happening around the world. Importantly, just owning the S&P 500 or the US Total Market Index already gives substantial international diversification, since roughly half of its revenue comes from outside the US. Meanwhile, because these companies are based in the US they avoid the corruption, political risk, and lack of the rule of law that often is associated with many countries outside of the US and Europe.

So, all in all, investors are better served by keeping their stock investments in US based companies.