The Benefits and Limits of International Diversification

International diversification is an asset-allocation method that spreads investments across multiple countries and regions that move differently, rather than concentrating them in one country's stocks. It may mix in not only developed markets like the U.S., Europe, and Japan, but also emerging markets.

The core idea is 'correlation.' Because business cycles, industry composition, and currencies differ by country, when one side is weak and another holds up, the overall portfolio's swings shrink.

Yet in reality, many people buy only their own country's stocks. This is called 'home bias.' For example, the U.S. accounts for around 60% of the world's stock market capitalization, yet U.S. investors keep about 75% of their stock assets at home. Korean investors concentrating only on Korean and U.S. stocks is a similar tendency.

The power of international diversification shows up clearly in the 'lost decade.' From 2000 to 2009, the U.S. S&P 500 returned about -0.9% annualized — investing for ten years still left you below principal. If you'd put in $1 at the start of 2000, you'd have had about 91 cents at the end of 2009.

But over the same period, international stocks, emerging markets, and small caps were actually positive. So a diversified portfolio evenly mixing the U.S., overseas, emerging markets, and bonds returned about +4.8% per year over the same decade (assuming equal weighting across several assets). Looking only at the U.S. it was a 'lost decade,' but widening to the world tells a completely different story.

Then there's the exact opposite case. From 2010 to 2019, the U.S. dominated. The S&P 500 returned about +13.6% per year, while developed markets excluding the U.S. (MSCI World ex USA) returned about +5.3% and emerging markets only about +3.7%. In other words, 'which country wins' flips from era to era. International diversification is closer to insurance that lets you capture a share even without predicting the future winner in advance.

The biggest misconception about diversification is that 'diversifying lets you avoid crashes.' It doesn't.

During major crises like the 2008 global financial crisis or the 2020 COVID crash, countries that normally move independently collapse 'simultaneously.' When fear spreads, investors worldwide sell all at once, so correlations between countries rise sharply, and at that very moment the diversification benefit weakens greatly. Just when the shield is needed, it thins out.

Still, studies find that this co-movement appears mainly in the 'short term,' and that over long periods, from the standpoint of fundamental growth (cash flows), country-by-country differences remain, so diversification benefits still exist for long-term investors. That's why it's most accurate to understand international diversification as a tool for 'long-term resilience' rather than 'crash prevention.'

When you invest abroad, you're automatically exposed to 'exchange rates.' Even if a U.S. stock rises 10%, if the won strengthens against the dollar in the meantime (the won's value rises), the return calculated in won shrinks below 10%; conversely, if the won weakens, the return grows larger. The exchange rate is a double-edged sword that can both magnify and erode returns.

Costs can't be ignored either. Overseas stocks and ETFs incur additional trading fees, currency-exchange costs, and foreign taxes on dividends. If these costs exceed the benefit gained from diversification, the reward for going abroad shrinks.

That's why our site, when showing returns, does not hide the maximum drawdown, drawdown (loss) duration, fees, and FX effect but displays them together. Because it isn't that 'diversifying is an unconditional win' — what's important is to see with your own eyes what you gain and what you pay.