When considering international investment opportunities, look to the lessons provided by Peruvian farmers.
I recently read a terrific article in the Economist which gave me a lot of food for thought to help explain to investors not only the benefits but also the challenges of diversifying your investment dollars.
In the mid-1980s, farmers were observed planting in 20-plus fields scattered around the mountain ranges in Cuyo, Peru. Researchers didn’t understand why the farmers did this. The field range was wide, requiring the farmers to trek back and forth along the mountainside to care for the various fields, an exhaustive exercise that baffled researchers. Why, they wondered, didn’t the farmers just stick with the closest fields?
Later, however, the method to their madness was revealed. The farmers were working with the knowledge that they would need at least half of the fields to produce their food, and the best fields weren’t always the ones closest to home. The unpredictability of the region’s microclimates, in other words, made it impossible to determine which fields would produce the best crops, so it was better for them to take advantage of the different microclimates and plant in many different areas.
So, by varying their work in the numerous fields, the farmers were helping to ensure their survival by diversifying their investments.
More Eggs, Same Basket
Diversification tends to be a leading factor for success, be it in investing or life skills. Having a diverse skill set makes an individual more adaptable to a changing environment, allowing them to achieve success against various challenges. Somewhat similarly, diversification in investing may allow one to better address the many different financial challenges that come from the market’s inherent volatility.
The problem, however, rests in what diversifying actually means to most people. Many people may not think big enough.
According to Morningstar, American stocks have performed better in seven of the past ten years compared to other world stocks. Impressive, yes, but the problem rests with how individuals tend to interpret the meaning of diversification. Based on the Morningstar research, if you tell an American investor to diversify, they will probably interpret the suggestion to mean “buy different stocks, but make sure they’re American.”
That may not be diverse enough; one may consider putting a lot of different colored eggs in the same red, white, and blue basket if you get what I’m saying. If you want to explore a sector that may react differently than US stocks, consider non-US markets— international stocks and bonds.
Think back to those Peruvian farmers. They succeeded because they were willing to step away from their comfort zones and trek across a mountain to find new and different fields to plant their crops. Making use of different markets may be right for some investors, but getting an investor to set aside their home bias remains the single biggest challenge for investors who are looking to diversify.
This “home bias” (or the habit of an investor to favor their own domestic market)isn’t hard to understand; home market investments have a familiarity that foreign markets, especially those several time zones away, simply do not. But such thinking doesn’t take into consideration the simple truths of market volatility. Everything changes, and safe bets can become sure busts without warning.
In that regard, American investors face an especially tough challenge with diversification. The U.S. accounts for one-half of the world’s stock market value but less than a quarter of its global GDP, only about 10 percent of the world’s listed securities and less than 5 percent of the world’s population. Also, many other countries use the American market as a bellwether, thinking “as goes the American market, so goes the world.” Research has shown all markets tend to get trampled in a stampede.
So if all that is true, why bother diversifying at all?
Just as a diversified farming plan may help Peruvian farmers to maximize their overall yield in an unpredictable environment, a globally diversified portfolio may provide investors the potential chance to side-step any one particular market’s serious decline and perhaps avoid getting trampled in the stampede. No matter which market you’re investing in, the return you earn may be driven by the fundamentals of that local market’s economy.
While a globally diversified portfolio may be right for your circumstance, it does not guarantee that the return will be more favorable compared to a local-market-only approach. But since there may be years when a global market outperforms your local market, it may be prudent to consider exploring that option.
Going Forward Globally
The solution: Keep it simple, and look to markets similar to your home market.
According to Gerstein Fisher Research, the S&P 500 over a 49-year time frame may have earned 10.6 percent per year on average, while the annual rate of return of a diversified portfolio of U.S. and international stocks may have earned around 10.77 percent. Not much of a difference over a very long period of time. So why bother, you may ask? What is key here is that the global portfolio may have outperformed the U.S. in many of those years, where in some years, the global market may have provided a positive return while US markets provided a negative return. And during those years, if an investor was invested in both markets, their balanced returns may have increased their odds of staying invested through challenging times, which is thought to be a necessary component for investment success.
There is a saying that investing is simple but not easy. As an investor and financial advisor, I can vouch for that. So if there is any way one can stack the odds in their favor, it may increase their chance to help meet their investment goals. Diversifying your investments outside of the U.S. may be a way to accomplish this.
The Economist: Finance and economics section of the print edition under the headline “Playing the field”
Gerstein Fisher Research: 9/23/18
International investing entails special risk considerations, including currency fluctuations, lower liquidity, economic and political risks, and different accounting methodologies. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph, or marketing piece to make decisions. The information contained herein is intended for information only, is not a recommendation to buy or sell any securities, and should not be considered investment advice. Please contact your financial advisor with questions about your specific needs and circumstances. Equity investing involves market risk, including possible loss of principal. There are no investment strategies, including diversification, that guarantee a profit or protect against loss. Past performance doesn’t guarantee future results. Equity investing involves market risk, including possible loss of principal. All data quoted in this piece is for informational purposes only, and author does not warrant the accuracy, completeness, timeliness, or any other characteristic of the data. All data are driven from publicly available information and has not been independently verified by the author.