The Hidden Risks of U.S. Stocks and Why Global Diversification Still Matters (EP.190)

0:28We all need to make smart decisions with our money. U.S. stocks might be one of the riskiest decisions for your portfolio. It sounds counterintuitive, right? The S &P 500 has dominated for years, delivering massive returns, but history tells us that no market stays on top forever. The question isn't whether U.S. stocks will slow down. To me, it's when. And when that happens, will your portfolio be ready? Many investors today are questioning the need for diversification, especially after years of U.S. stock market dominance. But outperformance never lasts forever, and markets are cyclical. And with valuation spreads between U.S.

1:08stocks and international markets continuing to widen, the long-term opportunity for global diversification has never been greater. Now, before we get into the rest of the episode, I do want to let you know that I have recently updated my nine-question financial assessment, you can go to smartmoneyquiz.com. You can answer that. You'll also get signed up for my newsletter. And when you sign up, do hit reply. Let me know what you think about the assessment. I'd love to make some tweaks so that it's more useful to you, my listeners. But let's get back to what we were talking about. It's no secret that international stocks haven't kept pace with U.S.

1:44stocks in recent years. In 2024 alone, international stocks, as measured by the MSCI World X USA Index, lagged U.S. stocks by nearly 20 percentage points. Over the last decade, the U.S. outperformed international markets by over 7 % per year. So it's no wonder investors are asking, do we even need international stocks anymore? But this skepticism you have to realize is driven by recency bias, which is the tendency to assume that recent trends will continue indefinitely. Behavioral finance experts Amos Tversky and Daniel Kahneman call this representative bias where investors mistake short-term patterns for long-term realities.

2:27History proves otherwise. Markets move in cycles and there have been long stretches where international stocks outperformed U.S. stocks. I think a really interesting thought exercise is to look at this decision as if it were 2011 because then if we were looking at the long-term data from 1970 through 2011, international stocks delivered better returns than U.S. stocks. And if we were sitting there in 2011 and just looking at the past decade, we would see that from 2001 to 2011, U.S. stocks underperformed international stocks by more than 2.5 % annually. And I remember those conversations back then when investors and really everybody, they just wanted more international exposure.

3:08But now that U.S. stocks have been leading, the trend is reversed. The takeaway is that short-term trends don't define long-term performance. The more returns fluctuate across asset classes, the more valuable diversification becomes. Now, this isn't the first time the S &P 500 has dominated, and it certainly won't be the last. But history shows that U.S. outperformance is often followed by stretches where other asset classes take the lead. And let's not forget, there have been long periods where U.S. stocks even underperformed the safest assets, like cash. So consider these three periods. From 1929 to 1943, from 1966 to 1982, and most recently from 2000 to 2012.

3:56Those are a 15-year period, a 17-year period, and a 12-year period where large-cap U.S. stocks lost to cash. And just imagine being fully invested in U.S. stocks during one of those periods. How long would you have been able to stick with your strategy while watching everything else outperform? This is where diversification plays a critical role. It's not about chasing winners. It's about ensuring your portfolio can weather all market conditions. Now, I do think that today, part of the reason I'm even talking about this is there are just so many investors that assume that sticking to U.S. stocks is the safest choice, but that assumption comes with major risks.

4:41I mean, there's the overconcentration that leaves you vulnerable just by betting in a single market, which is risky and no market leads forever. And it's not like the U.S. market is immune to downturns. And when you see that U.S. stocks have had returns of less than 4%, international stocks have outperformed 100 % of the time. And even when U.S. stocks had returns less than 6%, international stocks outperformed more than 90 % of the time. And just today alone, I think with the tech concentration, the concentration in the biggest names of the S &P 500 shouldn't go unnoticed. because when you start to diversify among international markets, you start to see there's some higher dividend yields, some lower valuations, and maybe even some different economic cycles that can enhance returns and reduce risk.

5:31At its core, diversification is about risk management and regret minimization. But here's the reality. Diversification never feels good in the short term because there will always be a part of your portfolio that underperforms. And that's hard to accept when one asset class like U.S. stocks appears to be winning year after year after year. And the behavioral challenge is this. We don't regret choosing U.S. stocks when they underperform because they feel familiar. But it does seem like we do regret choosing international stocks when they underperform because we feel responsible for making some sort of active decision.

6:10But the solution is not to abandon international exposure. The solution, in my opinion, is to normalize it. When international stocks become a permanent part of your portfolio, you stop viewing them as an alternative and start seeing them as an essential component of a long-term strategy. Here's a simple way to think about it. Imagine you're at the start of 2024. You know that one market, U.S. or international, will deliver a 24.6 % return and while the other will return just 4.7%, but you don't know which is which. A 50-50 globally diversified portfolio guarantees you a 14.6 % return, which is lower than the winner, but far better than the loser.

6:54And that's really how diversification works. You are just giving up the highest highs to avoid the lowest lows. So if you've been questioning whether diversification is still worth it, trust me when I say you are not alone. The temptation to go all in on U.S. stocks, in my opinion, has never been stronger. But history, valuations, and common sense all point to the same conclusion. Staying diversified is the best way to protect your long-term wealth. We know that the next decade won't look like the last one, and the question is, will your portfolio be ready? If you want to protect your long-term wealth and make sure your portfolio is built for all market conditions, not just the one we've been living in, then don't hesitate to reach out and let's talk about strategy.

7:42You can start by going to smartmoneyquiz.com, filling out some information. You can also schedule a call with me at callwithpeter.com. As always, thanks for listening. And until next time, to long-term investing. Thanks for listening to the Long-Term Investor Podcast. To access free financial resources and submit questions to be answered on the show, visit thelongterminvestor.com.

8:34Thank you.