Consider everything investors have been through in recent years: a global pandemic, rapid inflation, war in Europe, and volatile stock and bond markets. It’s reasonable to feel uneasy in the face of so much uncertainty.

Now imagine it’s the end of 2019 and you know what you know now. You’re asked to predict market returns over the next three years. Will stocks be up 25%? Flat? Down 25%?

The market was up almost 25% from 2020 through 2022. That includes last year’s 19% decline. Too often, people look only at year-by-year returns and don’t look at the total history of returns, which can be very informative.

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One of the best things about markets is that they don’t have memories. They don’t remember what happened last week or last year. They don’t even remember what happened a minute ago. Prices change based on what’s happening right now and what people think will happen in the future.

People have memories. Markets don’t. And that’s a good thing.

So as you start 2023, take a lesson from the market. Don’t begin this new year bogged down by what happened last year. Give yourself the opportunity to start fresh.

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Investment opportunities exist all around the globe, but the randomness of global stock returns makes it exceedingly difficult to figure out which markets are likely to be outperformers. How should investors deal with this kind of uncertainty?

First, they should remember that it’s challenging, at best, to predict a country’s returns by looking at the past, as shown by the performance of global markets since 2001 (see Exhibit 1). In the past 20 years, annual returns in 22 developed markets varied widely from year to year. (Each color represents a different country, and each column is sorted top down, from the highest-performing country to the lowest.)

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Recent history reminds us that emerging markets can be volatile and can lag developed markets. However, emerging markets represent a meaningful piece of the global investment opportunity set. A disciplined but flexible approach, which Dimensional has used for decades, can provide the means to access the emerging markets opportunity set effectively.

RECENT PERFORMANCE IN PERSPECTIVE

In recent years, the returns of emerging markets have lagged those of developed markets, with emerging markets underperforming US stocks by over 10 percentage points on an annualized basis over the past 10 years (see Exhibit 1). While recent returns have been disappointing, it is not uncommon to see periods when the reverse is true. For example, just looking back to the prior 10 years (2002–2011), emerging markets outperformed US stocks by more than 10 percentage points and other developed markets by 8 points on an annualized basis.

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Mac McQuown recruited me to help create the very first indexed portfolio in 1971. I was 24 years old and living in San Francisco, where more people my age were following the Grateful Dead than the stock market. The think tank Mac set up felt like a start-up, although it was long before anyone used that term. We were excited by the opportunity to turn academic research into a new way of investing. Many people thought we would fail. Some even called what we were trying to do “un-American.”

But we didn’t worry about the attacks; we focused on how indexing could improve the lives of investors. The fund offerings available at the time were actively managed portfolios that tried to outguess the market and were expensive, lacked diversification, and performed poorly. So-called star managers sold investors on their ability to win against the market; they sold products as opposed to solutions. Problem was, there was no compelling evidence they could reliably beat the market. We were confident that indexing—a highly diversified, low-cost investment solution that relied not on a manager’s ability to pick winners but on the human ingenuity of hundreds or thousands of companies—would change lives for the better.

Fifty years later, $9.1 trillion is invested in index mutual funds and exchange-traded funds (ETFs).1 This represents 51% of the total $17.9 trillion in equity ETFs and mutual funds. Six of the original academic consultants Mac hired to work on that first index fund went on to win Nobel Prizes. I have worked with four of them at Dimensional.

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