Why Diversification Matters: Lessons from History and Market Volatility
- Carson McLean, CFP
- Jan 27, 2025
- 4 min read
Last week, I came across a post by Larry Swedroe on Morningstar that struck a chord, offering timeless lessons on global diversification and risk management. Larry is a leading voice in evidence-based investing, and I’ve followed him for some time, particularly as many of his insights draw on Dimensional Fund Advisors (DFA) research from my time there. His recent piece felt especially timely.
As I write this, the markets are reeling from unexpected news about Deep Seek, a groundbreaking AI advancement that blindsided investors and disrupted expectations. Tech heavyweights like NVIDIA, closely tied to AI innovation, are currently down over 17%. We’ll see where it ends at market close, and I am sure it isn't going to last, but it’s a stark reminder of how unpredictable markets can be and why Larry’s message about preparing for uncertainty remains so important. While I encourage you to read his full article for a deeper dive, here are the highlights that stood out to me.
Market Leadership: A Shifting Landscape
Market leadership constantly evolves, shifting across countries and regions over time. In the 1970s, U.S. stocks lagged significantly while international markets, particularly Europe, outperformed. The 1980s marked a dramatic shift. The U.S. reclaimed ground thanks to strong economic growth, but Japan was the real standout. Japan’s stock market exploded during the decade, fueled by its manufacturing prowess and innovative management practices. By the late 1980s, Japan accounted for over 40% of global market capitalization, the U.S. just under 30%, a far cry from its current position.
In the 1990s, the narrative shifted again. The U.S. took center stage, driven by the dot-com boom and a soaring stock market. Then, the 2000s brought another reversal, with the U.S. experiencing a lost decade and emerging markets delivering superior returns.
By the 2010s, the pendulum swung back to the U.S. Technology giants and a booming economy propelled U.S. stocks to dominate once more. As history shows, market leadership can be fleeting. Betting heavily on one region, no matter how strong its recent performance, exposes investors to unnecessary risk. It’s easy to see winners in hindsight, but predicting the next leader, well, not so much.
Source: Dimensional Fund Advisors Returns Web Dataset. Data represents total return performance for the S&P 500, MSCI EAFE (Gross Dividends), and MSCI Emerging Markets (Gross Dividends) indices. MSCI EAFE data begins in January 1970, while MSCI Emerging Markets data begins in January 1988.
Disclaimer: This chart is for informational purposes only and does not constitute investment advice. Past performance is not indicative of future results. Returns reflect index performance and do not represent actual investor returns, which may be impacted by fees, trading costs, and other factors.
Diversification: A Guard Against the Unknown
Diversification isn’t flashy. As Larry notes, some investors dismiss it as "deworsification," frustrated by non-U.S. stocks lagging behind in recent years. But as Larry points out, diversification isn’t about chasing the next winner, it’s about preparing for what you can’t predict.
Take Deep Seek as an example, referenced above. A surprise announcement today that blindsided investors and sent ripples through the tech sector. The sudden news caused volatility, with companies like NVIDIA experiencing sharp drops. It’s a clear example of why diversification matters: markets are unpredictable, and concentrating your portfolio in one sector or region exposes you to heightened risk. It shields you from overexposure to any single region, sector, or stock, making your portfolio more resilient when the unexpected inevitably happens. Diversification may not guarantee smooth sailing, but it provides a strategy to navigate uncertainty and adapt to unforeseen challenges.
The Enduring Value of Principles
Larry’s perspective emphasizes principles over predictions—diversification isn’t about chasing maximum returns but about managing risks and smoothing out the bumps along the way. For long-term investors, this is essential. The goal isn’t to outperform in every cycle, it’s to build a portfolio that can endure the uncertainty of the markets.
If you’re tempted to dismiss diversification because the U.S. market has been on a tear, it’s worth asking, “What if I’m wrong?” A globally diversified portfolio hedges against overconfidence and ensures you’re better prepared for surprises—like the one we are seeing today.
Investing for an Unpredictable Future
Diversification may not capture headlines, but it’s invaluable during market turmoil. As Larry aptly notes, “Success can be fleeting.” How confident are you that the current market leaders will stay on top? Diversification isn’t about betting on today’s winners, it’s about preparing your portfolio to meet your goals, no matter what surprises the future holds.
About the Author
Carson McLean, CFP®, is the founder of Altruist Wealth Management, a flat-fee, fee-only fiduciary firm with over 15 years of experience helping clients navigate the complexities of financial planning. Leveraging his expertise in evidence-based investing and global diversification strategies, Carson empowers individuals and families to achieve their long-term goals with confidence and clarity.
Disclaimer: This content is for informational purposes only and is not intended as personalized financial, tax, or investment advice. While we strive to provide accurate and up-to-date information, all investments carry risk, and past performance is not indicative of future results. Any strategies or insights discussed may not be suitable for your specific situation. If you’d like to discuss how this applies to your financial plan, feel free to reach out.
