The Case for Global Diversification
As the largest economy in the world, the U.S. stock market has grown to represent approximately two-thirds of the global stock market. This means roughly one-third of the entire investment universe lies outside of U.S. borders. Yet many investors choose to invest exclusively at home, excluding a meaningful portion of the global market. At Truepoint, we believe U.S. stocks should remain a significant part of a diversified portfolio, but the benefits of investing internationally shouldn’t be overlooked.
Broad Diversification Reduces Risk
The concept of diversification is a core pillar of our investment philosophy and includes investing in both domestic and international markets. This ensures that we capture growth wherever it may occur, helping to offset any weak performance from another market. It is incredibly difficult to predict which country will outperform the rest of the world in any given period and the chart below illustrates just that. It shows the stock market return by calendar year for developed countries, ranked from highest to lowest return; the U.S. is in bright blue. As seen, there is no pattern or trend for which country will be a top performer in any given year.
In our view, the best odds of achieving long-term success require discipline and patience. This means shifting our focus from the short-term differences between country returns to the long-term benefit of reducing volatility and smoothing out returns with global diversification.
Real-World Examples
Beyond return unpredictability, history has shown many examples of country-specific shocks that resulted in noticeable underperformance versus the global stock market. Consider the dot-com era; in the late 1990s and early 2000s, investors flocked to U.S. internet companies in hopes of capturing outsized returns. Many of which failed to deliver the profits investors expected, leading to a period known as the “lost decade” for the U.S. From 2000 to 2010, the S&P 500 Index lost -9.1%, while the MSCI World ex USA Index (a developed international stock index), gained 17.5%.
An even more extreme example is Japan’s asset bubble. A dangerous mix of soaring real estate prices and stock valuations helped fuel an incredible stock market rally during the 1980s until the bubble eventually burst in February 1989. Japanese investors had to wait 34 long years before they saw the Nikkei 225 Index hit a new all-time high in February 2024.
The dot-com and Japanese stock market bubbles serve as a reminder that even the most dominant economies can experience prolonged downturns. And it is worth noting that economic cycles around the world are not always in sync, further adding to the benefits of allocating globally. In the above examples, U.S. and Japanese investors would have been able to help offset poor local market returns with global diversification.
Currency–An Added Layer of Diversification
Many investors shy away from international markets simply because they are less familiar, but there are additional costs and complexities associated with investing abroad. One of these complexities is currency. To buy a stock on a foreign exchange, you first must buy the local currency. This currency transaction adds another cost to investing abroad but also creates another potential source of return.
When U.S. investors buy international stocks, their return comes from two components:
- How the international stocks perform in their local market
- Changes in currency exchange rates
If the U.S. dollar gets stronger compared to other currencies, international returns go down. If the dollar weakens, returns get a boost. Currency movements thus create an additional variable that adds to the diversifying ability of international investments. The table below gives you an idea as to how much of an impact currency fluctuations can have on returns over time. In the early 2000s, a weakening U.S. dollar increased international returns, but in the next decade, a strengthening U.S. dollar hurt international returns.
Currency values change for many reasons, like interest rates and inflation, which are hard to predict. Over time, they can either help or hurt returns, but over longer periods of time, theory suggests that the effects of currency movements may be negligible, making it unnecessary to consider costly strategies aimed at eliminating exposure to short-term currency instability.
Over the long term, we believe the potential diversification benefit of international currency exposure outweighs any risks. With over half of a globally allocated portfolio tied to the U.S. dollar, exposure to international currencies adds another layer of diversification that can provide a cushion during periods of U.S. dollar weakness.
Take the Guesswork Out of Investing
In our view, there is no reliable method to predict whether U.S. or international stocks will perform better over a given period. Rather than trying to anticipate which region will outperform next, we believe in a disciplined, long-term approach to allocating across the global stock market.
The split between our U.S. and international stock exposure is directly linked to each region’s total market value relative to the global stock market value—an approach known as market capitalization weighting. As the U.S. stock market’s share of the global stock market changes, that drift will also occur within the stock portion of your Truepoint portfolio. Relying on market capitalization weights provides an objective, data-driven foundation for portfolio construction—free from market timing and speculation.
We believe that all investors can benefit from investing beyond their home country’s borders. At Truepoint, we’re not betting against the U.S., but rather expanding the investment opportunity set to ensure our clients’ portfolios capture performance wherever it occurs. If you’re interested in learning more about our investment philosophy at Truepoint, you can speak with someone from our team today.
