Large U.S. companies outperformed other investments over the last 20 years—but you should still diversify, pros say

Investing professionals are constantly thinking about two factors when building portfolios: risk and return.

In theory, the more return you hope to earn from an investment, the more risk you'll have to take on. In practice, this isn't always the case.

Consider the last 20 years' worth of investing data provided by Morningstar Direct in the chart below. On the X-axis, you have standard deviation. That's a measure of volatility; essentially, how much an investment tends to fluctuate in price. The Y-axis charts 20-year annualized total return.

While most asset classes follow the risk/return rules, a couple notable outliers emerge. Commodities, despite being one of the jumpier asset classes, offer the weakest 20-year return at 0.73%. You'd have done better in cash, which comes with virtually no risk.

The other standout is an investor favorite: U.S. large-company stocks — you know, the stuff that popular indexes such as the S&P 500 are made of. No asset class performed better over the past two decades than U.S. large-cap's 9.3%, despite several — including all other stock categories — coming with more volatility.

So have investors solved it? Stick with a large-company stock fund and forget everything else? Not exactly, financial pros say. Even if the bulk of your portfolio is in an S&P 500 index fund, there are two compelling reasons to branch out — maybe even into commodities.

And of course, do your homework and speak with your own financial advisor before making any changes to your portfolio.

Reason 1: Potentially boosting returns

The past 20 years of data would have you believe that large U.S. stocks offer the best returns of any asset class, but remember: past performance is no guarantee of future results.

That means while the S&P 500 may have cleaned up against other stock indexes of late, that may not be the case between now and the time you retire.

"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. And like Wayne Gretzky used to do, skate to where the puck will be, not where it is."

There are compelling cases to be made that, given their outsize performance, large stocks are overvalued compared with other asset classes, such as small-company and developed and emerging markets stocks, Stovall adds.

For long-term investors, he says, "nibbling at small- and mid-cap stocks as well as international investments might be a good thing."

Nibbling is the operative word, though. Most financial experts recommend retail investors keep the majority of their portfolio in a core U.S. stock fund and branch out from there.

"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 Research Services. "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."

Reason 2: Smoothing the ride

Even though large-company stocks proved less volatile than other types of stocks, investing in them over the past 20 years hasn't been a cakewalk. Despite the S&P 500 climbing overall over that period, investors still had to stomach drops of 56.8% during the 2007-2009 bear market, 33.9% in 2020 and 25.4% in 2022.

For many investors, a large dip in portfolio performance can induce the kind of panic that causes them to sell their assets at a depressed value, hurting their performance over time. That's why many financial advisors recommend spreading your bets across multiple asset classes.

By holding investments that move in different ways based on different market forces, you effectively ensure that something in your portfolio is always working.

That means, a core bond holding as well as — yes — commodities, may provide some ballast to your portfolio when your stock funds are sinking, as though two assets tend to move in the opposite direction of stocks.

Overall, having a broadly diversified portfolio, rather than one entirely in U.S. stocks, would have hurt returns over the last 20 years. But it also may have meant that an investor holding it wouldn't have panicked when their portfolio hit the skids, says Stovall.

"Diversification is usually a good way of smoothing out the ride."

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