There’s a saying that I’ve heard before, but it just came through my earbuds again this morning, via John Lee Dumas and his Entrepreneur On Fire podcast.
“The magic happens outside your comfort zone.”
That phrase is generally used in a life-coaching sense, but it has applications for investors, as well.
Let’s start with the idea of “home-country bias.” When new clients reach out to our firm, they generally have portfolios heavily skewed toward big U.S. stocks.
That’s understandable. It’s what we know. Just driving around my neighborhood, I pass locations of big, publicly traded domestic companies such as Kroger, McDonald’s, UPS, FedEx Office, Dollar Tree, Starbucks, Walgreen’s, Bed Bath & Beyond, Whole Foods, Sherwin Williams and . Meanwhile, I’m writing this on an Apple computer. I have Facebook, Twitter and Google open in my browser tabs – you get the point.
These are familiar companies. As investors, they’re within our comfort zones. When Americans think of stocks they want to buy, we typically turn to those companies. Not only are they part of our day-to-day experience, but the U.S. financial media report exclusively on those companies.
That’s why it doesn’t occur to most Americans to buy Japanese or German or Australian stocks. Even if we wanted to buy those stocks, they’re traded on foreign exchanges, making it a very difficult transaction.
But there’s a good reason to diversify beyond big domestic stocks. It smooths returns and helps you avoid concentration in an underperforming asset class.
For example, in the so-called “lost decade,” between January 2000 and December 2009, several stock-and-bond asset classes delivered a positive return, while large U.S. stocks shed 9.1%, in total. You can see this divergence in this chart, compiled by Dimensional Fund Advisors.
Source: Dimensional Fund Advisors
Non-U.S. investing is outside the comfort zone for most of us. In fact, even domestic small-cap investing is unfamiliar to many Americans, as is the notion of diversifying into growth and value stocks, rather than focusing on one or the other.
In 2015, top-performing indexes were the Russell 1000 Growth Index, the Dow Jones U.S. Select REIT Index and the MSCI World Ex-U.S. Small-Cap Index. In other words, not the typical bunch of large U.S. stocks that most Americans gravitate toward.
That’s not to say you should have known to purchase funds tracking those indexes. The point is: Nobody can predict which global asset class will be a big winner or big loser in any given year.
The best strategy? Diversify beyond your comfort zone. Own the entire worldwide market, and don’t attempt to pick winners and losers.
