Whether you are in the investment industry or not, one of the first lessons everyone learns is the importance of diversification. “Don’t put all your eggs in one basket,” so to speak. Over time we have learned that diversification works. Stocks that are not alike will not perform alike, so oftentimes when one set of similar stocks is doing poorly, diversified stocks are doing better and vice versa. This way, your entire investment portfolio is not doing poorly all at once.
There have been many times during market history when investors began to seek concentrated investments rather than stay diversified. The “tech bubble” is a prime example of this behavior. Investors started putting large amounts of money into any and all technology stocks without regard to their underlying value. After all, technology was changing the world. Technology certainly has changed the world. However, the stock prices of many early technology stocks did not fare as well as their businesses, or they simply did not survive.
When looking at the entire investment market there are two primary ways to diversify U.S. stocks:
1. Invest in bonds, and
2. Invest in international stocks.
Bonds provide insulation against sharp drops in the stock market. Typically, when stocks do poorly, investors flock to income-oriented bonds that are more protected from economic declines. International stocks are oftentimes diversified from U.S. stocks due to their varying economic conditions. Although our world has become much more global, different economies still have different growth cycles.
If your portfolio is diversified, you may be looking at your performance for 2018 and wondering why your investments are not living up to performance that is displayed across the news. U.S. news typically reports three different indices: S&P 500 Index, Dow Jones Industrial Average Index and NASDAQ Index. Just because three different indices are reported, it does not mean they are diversified. All three of these indices hold all U.S. stocks. And, most are dominated by high flying technology-oriented companies like Amazon, Apple and Google.
Bonds and International stocks have both performed very differently than U.S. stocks, as illustrated in the table below. In fact, both bonds and international stocks are negative year-to-date. Bonds have been hit by rising U.S. interest rates and international stocks have been hit by threats of international tariffs from the U.S. as well as a rising value of the U.S. dollar versus their currencies.
Before you start abandoning these diversified investments and seek to participate in the winners, remember another steadfast tenant of investing—“Buy low, sell high.” Keep this in mind when you consider that U.S. stocks have experienced a price return of 197% during the past 10 years versus price performance of 55% for international stocks. The Wall Street Journal reported that U.S. stocks are trading at their highest premiums to international shares in years. With “buy low, sell high” in mind, which investments are you most interested in?