Plenty of investors make the mistake of focusing their equity portfolios on large-cap domestic stocks. When the S&P 500 has a year like it did in 2013, that strategy works out great. In fact, large-cap U.S. stocks, both growth and value, have done pretty well in 2014, relative to other equity asset classes. But it's impossible to say what might the top index category might be in 2015. Emerging markets small-caps? Developed Europe growth? Asia-Pacific value? Who knows? Don't be one of those people who miss returns -- or fails to smooth returns -- because you are too narrowly invested.
As Americans, we like to think we "know" something about the companies we invest in. Whether or not the average retail investor knows enough to have an edge is debatable. (Actually, in my book, there's no debate. A retail investor -- or trader -- simply cannot get an edge against the institutions because of the latter's superior research capabilities and access to high-speed trading. Fortunately, the retail investor does not have to attempt to beat the pros -- and, in fact, should not even attempt that -- in order to have returns commensurate with his or her goals. But I digress.)
Back to that idea of knowing about the companies in which we invest. The big problem with that, for U.S. residents, is that our news media only reports on companies based or listed here. Occasionally, a company like Samsung sneaks into the reporting, making U.S. investors want to snap up shares, only to realize that the company is not listed here.
So what does that mean for the investor who understands the value of diversification?
First, in addition to market-cap allocations, the well-diversified portfolio includes regional allocations. For example, I use foreign large-cap funds in most of my clients' portfolios. The weightings differ, depending upon investment objective. In particular, I use some vehicles to capture returns from the overseas large-growth category. One example of a fund from that category is the Vanguard International Growth Fund (VWIGX). This fund's assets total $22 billion. As the name suggests, it invests in non-U.S. companies with strong growth potential.
Top holdings are Baidu (BIDU), Tencent Holdings, AIA Group and SoftBank. As you can tell, most of those are unavailable for purchase as single stocks for U.S. investors, meaning that a fund is the only viable way to get access to some of these companies.
One of the key reasons to venture beyond our own shores is to offset those times when U.S. stocks underperform other global indices. Of course, in 2014, U.S. returns have outpaced those of other regions, but that's not a reason to bail on overseas investments. In fact, if anything, it's a reason to hold foreign stocks, since underperforming investments are often the ones that attract institutional funds -- contrary to the "performance chasing" mistake that most retail investors make.
To smooth returns in the equity portion of your portfolio, over time, it's best to venture beyond the S&P 500 or the hot IPOs that get the constant attention from the domestic financial media.