Perhaps the most compelling reason is that as I mentioned above, together these asset classes represent the blue chip companies of the world. They invest in “the best” companies with “the best” management, “the best” products and “the best” prospects.
As such, they are rarely available at bargain prices. That means they aren’t likely to have the best long-term performance.
However, in any severe market downturn, the stocks of these blue-chip companies are likely to hold their value better than those of value companies, small companies and emerging markets companies.
The best way to reduce overall portfolio risk is to invest in bond funds. But when you’re focusing on the equity side of a portfolio, I think a good case can be made that large blue-chip companies help mitigate risk.
It’s easy to invest in international large-cap blend stocks.
The performance numbers in this discussion are based on returns of two excellent and inexpensive Vanguard index funds: 500 Index VFINX, +0.03% representing the S&P 500 and Developed Markets VTMGX, +0.08% representing EAFE.
There’s no way to know the future, of course, but I think Vanguard Developed Markets has the potential to produce better long-term returns than the S&P 500.
Developed markets holds 1,367 companies with an average size of $31.5 billion. The 500 Index, Fund on the other hand, holds only 504 companies with an average size of $73.8 billion.
With so many more companies, the EAFE fund is less subject to potential damage that any one or two stocks could do. At the same time, more than doubling the number of holdings provides lots of corporate diversification.
The size issue is significant, because over the long term, smaller companies have done better than larger ones. Although $31.5 billion hardly qualifies as “small,” it is less than half the average in the S&P 500.