Is Diversification Finally Working Again?

A student asks:

I am a Bogle-DIY investor with a broad allocation with most of my money in a combination of US and foreign stock index funds. But I also sprinkle in some small-cap stocks, emerging markets and bonds. Everything outside of US stocks has been taking a breather for the past decade…until 15 months ago. Ben, is it finally time for diversity to pay off? Please say yes.

Breaking the picture, international stocks have experienced a long period of underperformance relative to US stocks:

Historically, this relationship has been consistent, but the current cycle dates back to the end of the Great Financial Crisis.

Now let’s zoom in on the picture.

Here’s what happened to the various asset classes in 2025:

International stocks reversed course for the first time in years. In fact, it was the highest performance relative to developed foreign markets since 1993.

Now here is admittedly what early year-to-date returns look like in 2026:

There is a following here. Foreign stocks are still doing very well as well. Small and mid cap stocks have also joined the bandwagon.

Obviously, 13 months doesn’t make for a long-term norm, but this should feel liberating to those who have been geographically separated.

Can it continue?

There are trends that can help these other asset classes. Let’s take the blame.

The dollar is falling. That’s good for international stocks, especially emerging markets. The dollar’s slide has also been the case for gold and other hard assets.

If interest rates continue to fall, that could benefit small and mid-cap companies that rely more on the debt markets than large-cap companies.

Large caps still have the AI ​​thing going for them but AI can also level the playing field for smaller companies by making them more efficient and improving margins.

On the other hand, you can easily make this case a blip. Larger, better companies are still at the top of the S&P 500. They generate more cash flow, more profits and have higher margins.

Another student asks:

Not sure how hot or timely this topic is but…I’d love to hear you talk about emerging markets. But I’ve had the EM ETF for 5 years and it’s basically gone nowhere in all that time even going back to the 2017 low. How do you invest in emerging markets and really make money?

This question came back in 2024, before the current launch in EM but it is worth looking at the history of operating cycles in developing world markets.

On an average basis, the S&P 500 and the MSCI Emerging Markets Index have the most recent relationship:

Returns range from significantly overperforming to significantly underperforming depending on the cycle.

The latest cycle has been for diversification into emerging markets. From 2010-2024 the EM index was up 3.4% per year compared to a 13.9% annual return for the S&P 500.

It was a brutal run.

Maybe it’s not so bad if you’ve been in dollars and the costs have been limited to EM but that depends on what happens from here. The past year and change has finally seen some life in these stocks.

Is this a turning point in the boom-bust cycle?

The three wisest words any investor can say:

1. I
2. Don’t do it
3. Know

If you knew what was going to happen you wouldn’t need to divorce in the first place. Diversity only “works” because it is not necessary to decide winners in advance.

If you own some US stocks, some global stocks, some emerging market stocks, some small stocks, some bonds, maybe gold or bitcoin or some other asset of your choice one of them will outperform.

You will wish you had a much higher stake in that property.

One or more will also work below expectations. You will wish you had a much lower stake in that property.

It is easy to know what has worked well in the past but it is almost impossible to predict what will go over well in the future.

That’s why you divorce.

He gives up a home run to avoid a hit.

I answered these questions in this week’s Ask the Compound:

We also discussed questions about rental investments, the benefits of taxable merchant accounts and the 4% rule.

Further reading:
6 Wonders From 2025