Beating the diversification drum
The markets have been off to a good start, and better than most expected this year. And yet, with the news headlines about Europe remaining almost universally negative and the U.S. economy showing signs of strengthening, some investors have been questioning the wisdom of holding equities of companies incorporated in Europe.
Yes we think Europe is in a recession, yes the politics around this are toxic, yes Europe will likely continue to drive volatility, yes the U.S. economy may be in better shape than Europe, and yes, we are more confident in the potential for positive equity returns in the U.S. than elsewhere. At first blush, this seems to be a compelling case to significantly overweight U.S. stocks and underweight non-U.S. developed and emerging market stocks.
However, the chart serves as a humbling reminder of the difficulty of successfully choosing the leading asset class year in and year out – history shows that the top spot is pretty random.
Annual index performance suggest the value of diversification from 1998-2011
One way forward might be diversification. At its most elemental, diversification is recognition of the fact that no matter how confident you are in forecasting, no one knows with absolute certainty what will happen in the future. If you truly knew what was going to happen, you would only purchase the asset that would go up the most in the future and you would know exactly when to sell it at its highest price point and what to buy next. But reality is different. In real life, you diversify, because at the end of the day you do not know what will happen. If you do it right, then when some elements of your portfolio are in the shade, other parts of your portfolio may be having their day in the sun. Keep in mind that diversification can’t guarantee a profit or protect against loss.
International: MSCI® EAFE Index. An index, with dividends reinvested, representative of the securities markets of twenty developed market countries in Europe, Australasia, and the Far East.
Real Estate: NAREIT Equity REIT Index. An index, with dividends reinvested, representative of tax-qualified REITS listed on the New York Stock Exchange, American Stock Exchange, and the NASDAQ National Market System.