In 2014, the S&P 500 returned 13.69% with dividends reinvested. Meanwhile, many diversified investors earned substantially less than that, due to falling commodity prices and poor international stock market returns after adjusting for the strong dollar.
Some of these investors were extremely disappointed by their underperformance. Many drew the conclusion that it was time to change course and adjust for the reality that U.S. stocks are best. After all, if the S&P 500 has beaten almost every other asset class over the past three years, why invest in anything else?
That was the exact wrong conclusion, and it stems from a very common investment mistake.
The most common investment mistake we see is an investor bailing when one asset class does poorly. Usually, the result is that the asset class the investor abandoned ends up rebounding, and the one that did well — and which the investor eagerly jumped into — isn’t as strong the following year, leaving the investor frustrated once again.
This illustrates the whole idea of diversification, and the whole point of sticking it out for the long term. Nobody can predict which asset class will perform best next year.
Let’s make one thing clear: A diversified portfolio is not a silver bullet. There will be times that a diversified portfolio, which includes international holdings, will perform poorly compared with the U.S. stock market. This investment truth should not deter you from staying diversified.
Late last year, we had several clients suggest we should sell all our international holdings given their poor performance relative to the U.S. over the course of 2014. Guess which asset class has been one of the best so far in 2015 — international stocks.
I remember one client complaining about a particular mutual fund we owned and how terrible the fund’s performance once. In fact, the fund was in the top 10% of its peer group. It was actually the asset class the client was complaining about, since all funds in that class were down in 2014.
Lesson: Be careful not to give up on an asset class right before it turns around.