U.S. AND FOREIGN STOCKS are highly correlated, with monthly returns that move in the same direction almost all the time. Because of this, some have argued that there’s scant reason to diversify internationally.
But there’s a small problem with this argument: Just because investments move in the same direction doesn’t mean they generate the same return. For proof, consider the past 20 calendar years.
Over that stretch, there were only three years when U.S. and foreign developed market stocks didn’t head in the same direction, either both rising or both falling. That would seem to suggest that foreign stocks didn’t provide much diversification benefit—plus, in each of the three anomalous years, it turns out that U.S. stocks rose, while foreign stocks fell.
Case closed? Maybe not. Next, consider the gap in annual performance. In 17 of the past 20 years, the gap between the total return of U.S. and foreign stocks was six percentage points or greater. In other words, almost every year, there’s a sharp difference in performance. In those years, if you’d owned just U.S. stocks or just foreign stocks, the “no diversification benefit” argument wouldn’t have seemed so convincing. Moreover, these big return differences often persist for a decade or more. U.S. shares have dominated during the most recent decade, while foreign stocks—especially emerging markets—outperformed during the decade before.
How are we doing in 2021? As of Friday’s market close, Vanguard Group’s S&P 500 fund had gained 21.9%, while its international developed markets fund was up 14.1%—yet another year with a sizable performance gap.