Disciplined investing feels like punishment

You know that the keys to long-term investment success include a diversified portfolio and periodic rebalancing. Meaningful diversification requires including international stocks, even when the recent performance has been poor and the future looks uncertain. Maintaining international stock investment discipline over the last five years feels like punishment.

International stocks have under performed US stocks over the last few years. The five year annualized return for the MSCI ACWI ex US index (a broad market index of non-US stocks) returned 4.18%, and the S&P 500 annualized return was 14.58% over the same period. source: morningstar.com

Recent news from Europe(Paris attacks, record low German bond interest rates, continued political and economic uncertainty in Greece) begs the question – why not just stick with the US stock market, since it is doing much better than the rest of the world.

The answer is recency bias, a behavioral finance term describing the tendency to place too much emphasis on the recent past when reviewing historical information. Over the long term (20+ years), US and International stocks have similar rates of return. The benefit of owning International stocks lies in their low correlation with US stocks. A diversified portfolio of 40% International and 60% US stocks has lower volatility and a higher annualized return than a portfolio of 100% US stocks over the long term.

A review of the Periodic Table of Investment Returns serves as a good reminder that it’s impossible to consistently pick the winning asset class. In the early years of this millennium, International stocks outperformed US stocks. To see that, you need to look beyond the last five years.

When you are investing for the long term, you need to ignore recency bias and stay the course. Rebalancing in this environment means selling US stocks(the winners) and buying International stocks(the losers), even when it feels like punishment.

Tags: Investing