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"Value Added" Part 2 - Effective Diversification

Our Value Added IndexingTM approach to investing has several aspects above and beyond using index and market tracking funds to build portfolios.  As part on an ongoing series, we're pleased to highlight several of our "Value Adds".   Part 2 looks at effectively diversifying among several areas of the markets.

Lessons from the last two decades

Using the decade of the 2010s as a reference, investors might think that holding only U.S. stocks makes sense.  The S&P 500 Index, a proxy for large cap U.S. stocks, had annualized returns of 13.56% from 2010 to 2019, far outpacing international and emerging markets stocks.  

However the prior ten years, sometimes called “the lost decade”, told a different story.  The period included both the bursting of the “dot-com” bubble, and the global financial crisis. The S&P 500 Index had a total cumulative return on -9.10%.  International developed markets and emerging markets stocks had a total cumulative returns of 17.47%, and 154.28% respectively.  So investors were certainly rewarded for international diversification.

We do know that U.S. stocks, having done so well over the last decade, are trading at significantly higher valuations than international stocks.  That is why, in part, that Vanguard has the perspective that international and emerging markets stocks will outperform U.S. market over the next 10 years.*

The lesson - over long periods of time, investors may benefit from consistent exposure in their portfolios to both US and non US equities. While both asset classes offer the potential to earn positive expected returns in the long run, they may perform quite differently over short periods.  

Real Estate Securities (REITs) are another area of the markets that provide diversification.  REITs provide an opportunity to invest in different areas of the real estate markets, without owning properties directly.  A diversified REIT portfolio, including both U.S. and international securities, provides exposure to office buildings, industrial buildings, hotels and resorts, retail properties, and health care properties, among others. 

What will the future hold?  

There is no reliable evidence that investors can predict which area will perform better in advance. An approach to equity investing that uses the global opportunity set available to investors can provide significant diversification benefits.

To provide effective diversification, we incorporate the following areas in our global stock portfolios:

*Vanguard Market Perspectives, February 2020

The author does not intend to provide investment, legal or tax advice as these materials are for general educational purposes only.  Please consult your legal, tax or investment professional for advice on your particular situation. This material is derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. It is not intended to be a solicitation, offer or recommendation to acquire or dispose of any investment or to engage in any other transaction. Investing involves risk including the possible loss of principal. Past performance does not guarantee future results. Please refer to RRCM’s Form ADV Part 2 for additional disclosures regarding RRCM and its practices.