Published by Taylor Financial Group
“Those who cannot remember the past are condemned to repeat it.” A recent Advisor Perspectives article reminded me of this famous statement, which was a warning by Spanish philosopher George Santayana. This cautionary remark rings true for me as I recall how many times I’ve had to talk clients off the ledge, so to speak, when stocks in their portfolios performed poorly. As many of you know, we have favored international and emerging markets for over a year, and they have outperformed the S&P 500 Index during that time. However, I see clients’ fears act up a lot with international stocks because many clients assume international investing is riskier than domestic investing. So, when international stocks are not doing well, clients tend to panic and can make unnecessary investing mistakes. But I want to remind you that the performance of stocks, near and far, are always going to fluctuate. That’s just the way the market works and history echoes that fact. Ultimately, your international investments are not necessarily riskier than your domestic ones. So, don’t be swayed from diversifying your portfolio with international stocks.
Historically, international stocks are good for diversification. Being a successful investor requires having a good memory so that you don’t forget the reality of the past. For instance, if we look at the five years leading up to the 2008 financial crisis (2003 through 2007), where they returned 19.9% a year, and we compare it to the next nine years following the crisis (2008 through 2017), we can see a vast difference in the performance of international stocks. In the earlier years, international stocks far outperformed U.S. stocks, which then completely reversed in the latter years. As Advisor Direct explained it, “In general, dramatic outperformance (underperformance) is accompanied by rising (falling) valuations, which generally leads to reversion in returns – higher valuations predict lower future returns, and vice versa.” In short, it’s called mean reversion. International stocks, like any stocks, basically have to fluctuate.
Let’s bust the myth that global diversification doesn’t work. Unfortunately, global diversification has had a bad reputation ever since the financial crisis in 2008. Because all risky assets experienced severe price drops during that time, many investors assume that global diversification doesn’t work. But that is not a great conclusion. What investors should focus on instead are two important facts. First, investors have different risk tolerance levels. And, that’s important to understand because your portfolio should reflect your level of risk. If your portfolio is not aligned with your risk tolerance, it can be the cause of otherwise avoidable losses, which can be unfairly attributed to poor performance of international investments. Without effective guidance and advice by a financial advisor, investors can fall into the trap of believing that the blame belongs to their investments in international stocks when, in fact, it belongs more to improper assessment and alignment of risk.
Second, investors forget that globally diversified portfolios are meant to enforce long term goals. For investors who have a short-term planning horizon, global diversification could very well be the wrong option. A study by Clifford S. Asness, Roni Israelov, and John M. Liew called International Diversification Works (Eventually), found that “over the long run, markets don’t exhibit the same tendency to suffer or crash together.” The study further noted that “country specific economic performance dominates long-term performance, going from explaining about 1% of quarterly returns to 39% of 15-year returns and rising quite linearly in time.” This reinforces what we are constantly telling our clients – don’t let short-term results derail your long-term goals.
Ultimately, we continue to believe that diversification works and that international investments play an important role in a diversified portfolio. As an investor, you must do your best to remain level-headed in times of volatility and performance fluctuations, and not let panic drive your decision-making. As your financial advisor, we help keep you grounded and stay on course toward pursing your long-term goals.
If you’re wondering whether your portfolio is aligned with your risk tolerance, click here to take our Risk Tolerance Questionnaire and we will call you to discuss your results. We can also talk about whether your portfolio is effectively diversified for you. After all, our goal is to help you live life to the fullest while giving you financial confidence.
Sources:
Advisor Perspectives, Don’t Abandon International Diversification, April 16, 2018
Financial Analysts Journal, International Diversification Works (Eventually), 2011
Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.
Additional risks are associated with international investing, such as currency fluctuations, political and economic stability, and differences in accounting standards.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
Securities offered through Cetera Advisor Networks LLC, Member FINRA/SIPC. Investment advisory services offered through CWM, LLC, an SEC Registered Investment Advisor. Cetera Advisor Networks LLC is under separate ownership from any other named entity.