Investors today face a conundrum: do you stick with what’s worked or branch out for potential gains? That question is sparked by new investing data that shows over the past 20 years, large U.S. company stocks have outperformed all other major asset classes while taking on less risk.
Morningstar research shows large-cap U.S. stocks, as represented by the S&P 500 index, provided an annualized return of 9.3% over the past two decades. Meanwhile, their standard deviation—a measure of price swings—was just 14.5. Compare that to small-cap U.S. stocks, which returned 8.9% with an 18.9 standard deviation over the same period.
In investing, typically more potential reward comes with more risk. But large U.S. stocks broke that trend, delivering top returns with lower volatility than rivals.
Does that mean investors should abandon diversification and just pile into an S&P 500 index fund? Financial professionals say not so fast. Here are two reasons they argue investors should still spread their bets.
Chasing Past Returns Is Risky
Just because large-cap stocks ruled over the last 20 years doesn’t guarantee they’ll stay on top. As the saying goes, past performance does not predict future results.
“We’ve had almost 10 years of international stocks not performing, but there’s also something called reversion to the mean,” says Sam Stovall, chief investment strategist at CFRA. “Eventually, they’ll come back to the fore.”
Stovall argues sectors like small-cap and international stocks look attractively valued today compared to large U.S. stocks. If that’s the case, they could be positioned to outperform in the years ahead.
Still, most experts say large-cap U.S. equities should remain the core holding for most investors. But they suggest complementing that with “nibbles” of other assets that currently offer better value.
“If you want to keep things simple, I think large-cap U.S. stocks plus international would be the place to start,” says Amy Arnott, a portfolio strategist for Morningstar. “Then if you want to bolt on more specialized asset classes, like real estate or small-cap stocks, I would keep those to a smaller percentage of the portfolio.”
Diversification Smooths the Ride
Even though large-cap stocks were less volatile over the past 20 years, investing in them has still proven to be a bumpy ride.
The S&P 500 experienced gut-wrenching drops of 56.8% during the Great Recession, 33.9% during the COVID-19 crash, and over 25% during the 2022 bear market.
Watching your portfolio get cut in half can test the nerves of any investor. And many end up selling low in a panic, cementing their losses.
Broadly diversifying across asset classes can help avoid this by ensuring at least part of your portfolio is holding up when another part craters.
Bonds and commodities, for example, often zig when stocks zag. So holding some funds in those assets can offset declines in your stock holdings.
“Diversification is usually a good way of smoothing out the ride,” says Stovall.
Over the past 20 years, holding a diverse mix of assets hurt returns compared to just large-cap U.S. stocks. But it also may have given investors the fortitude to stay the course rather than sell out of fear.
Weighing the Pros and Cons
So what’s the right approach today for long-term investors? As with most things in investing, there are good arguments on both sides.
The case for just holding a low-cost S&P 500 index fund is compelling. Large U.S. stocks have shown resilience over the past two decades. And sticking with just one asset class means extreme simplicity.
But experts warn investors shouldn’t let recent performance cloud their judgment. Chasing returns often backfires as leadership rotates between asset classes over time.
There’s also risk in having all your investment eggs in the large-cap basket. When that market hits an inevitable rough patch, you won’t have any ballast in your portfolio to offset the downdraft.
As always, investors should speak with a financial advisor to map out the appropriate asset allocation based on individual risk tolerance, time horizon, and goals.
For most retail investors, the consensus strategy aligns with Arnott’s advice: Maintain a core holding of large-cap U.S. stocks, complemented by positions in international equities and other diversifying assets.
The exact percentage in each depends on your specific situation. But blending assets can smooth out volatility while ensuring you benefit from future opportunities wherever they emerge.