Using The Rear View Mirror

After spending the last twenty years with the strongest stock market in the world, why would we bother diversifying? This is likely what Japanese investors were saying in the late 1980s. Following a 1,500% return over the 20 years prior, the Nikkei swelled to 48% of the global investable stock universe.

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The Nikkei would go on to lose 38% over the next 12 months and would ultimately erase 81% of its value. Still 25 years later, the Nikkei needs to double to make new all-time highs. A Japanese investor would have done well to expand beyond the Nikkei; since the 1989 peak, U.S. stocks are up 951%, European stocks are up 682%, Emerging Market stocks are up 793% and Pacific Ex-Japan stocks are up 770%.

Now to be clear, diversification does not save you in the short run. In fact, recently there has been very few areas of the world where equities have not been hit (as of Friday, August 21).

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Diversification might not save you in the short run, but it can help in the long run. The point is not that you have to subscribe to asset allocation. However, what should be made perfectly clear is that investing using the rearview mirror is an awful strategy. Whether it’s stocks, countries, sectors or strategies, chasing what has worked has a high probability of leading to disappointing results.