Market Highs: Why Diversification Still Works

Global Investment Returns Yearbook Reveals Profitable Yet Volatile Stock Market

A viral clip from Ferris Bueller’s Day Off, featuring economist Ben Stein’s monotone explanation of the Smoot-Hawley Act, has sparked renewed interest in economic history. The Act, which aimed to raise tariffs but inadvertently deepened the Great Depression, raises questions about its relevance in today’s economic landscape.

On Tuesday, UBS released its Global Investment Returns Yearbook, offering a comprehensive analysis of 125 years of market performance. Compiled by Paul Marsh and Mike Staunton from the London Business School, along with Elroy Dimson from Cambridge University, the report highlights the long-term profitability of stock investing alongside its inherent volatility.

Since 1900, U.S. stocks have delivered 6.6% annualized inflation-adjusted returns, significantly outperforming bonds at 1.6% and bills at 0.5%. Global markets outside the U.S. averaged 4.3% annually, reflecting consistent U.S. market outperformance—though recent months have shown a shift in this trend.

The study emphasizes the volatile nature of stock markets, noting that recovery from major downturns often takes years. Investors waited 15.5 years to recover from the Great Depression, 10 years following the 1970s oil shock, 7.5 years after the dot-com crash, and four years post-global financial crisis.

International diversification, a strategy popularized in 1974, has delivered mixed results. While most countries benefited, U.S. investors have seen little improvement in returns. The authors still advocate for diversification, cautioning that while it enhances the likelihood of better outcomes, success is not guaranteed.

Cross-asset diversification has also shown long-term benefits, despite recent inflationary periods challenging its effectiveness. The 60/40 portfolio model (60% stocks, 40% bonds) remains a reliable strategy, offering better risk-adjusted returns than stocks or bonds alone.

Stock market diversification pays off as well. Analyzing 64,738 companies across 42 countries from 1990 to 2020, the report found that 57% of stocks underperformed Treasury bills, and 71% trailed the index. However, gains from top-performing stocks more than compensated for these losses.

Timing the market is notoriously difficult. Avoiding the worst 20 months over the past 125 years would have boosted returns by over 3% annually, but missing the best 20 months would have reduced returns by nearly 3% annually. The authors advise broad diversification unless one possesses exceptional stock-picking skills.

Despite concerns about investing at market highs, historical data shows they are not reliable sell signals. Elroy Dimson remarked that investors who exited the U.S. market fearing overconcentration missed out on significant gains.

Paul Marsh’s advice for investors is straightforward: “Don’t check your portfolio too often. Stay invested.” This timeless strategy remains particularly relevant amid today’s market uncertainties.