It is a mistake to think your portfolio is properly diversified simply because you have chosen stocks or index funds across differing sectors. That’s not enough. Investing across all sectors will not coverall asset classes, but investing across all asset classes will cover all sectors. There is a big international world out there. Don’t neglect it in your investing horizons.
Many average investors suffer from ‘home country bias’, which means they tend to invest only in the country in which they live. For example, if you purchase stocks diversified across all sectors located within the US, performance might depend more upon how the country performs than the quality of the individual companies chosen.
Diversification is an important part of building a well-constructed portfolio that will grow your assets. This is why we use as many as 15 or 16 asset classes when building our portfolios. Investing abroad, including emerging markets, helps to strengthen your portfolio by expanding the efficient frontier. An efficient frontier graph is presented with nearly every portfolio review. While it is extremely difficult to choose individual stock in emerging markets, it is very easy to participate in these markets through the use of ETFs.
Despite the fact that the international asset class was the worst performing asset group from 1989 through 2007, it is still an important asset class to include in a portfolio. In addition to adding developed international countries, the emerging markets should also be included. Do keep in mind that as the world continues to trade with each other, many of these international asset classes become highly correlated with the U.S. market.
There are times when diversification does not work in the short-term, but remember to be a long-term investor. Even if you are using a momentum strategy, think long-term.