The Investor's Fundamental Attribution Error

April 07, 2023

If diversification isn’t the most common buzzword in the investment industry it must at least be in the top five. Everyone has heard of it. The finance community has done a pretty good job instilling the message that diversification is a good thing. The word has a positive connotation as it relates to investment portfolios. I have a hunch that if you asked 100 people whether they think diversification is a positive attribute of an investment portfolio, some large percentage would say yes. Probably more than 75%? I have no idea. But that would be my guess. Well done, investment industry.

But the investment industry has not done such a good job communicating what diversification actually looks and feels like. Perhaps your equity portfolio underperformed your benchmark (probably the S&P 500) for the month or the year or whatever time period you’re using. There are a few possibilities. Most likely it is one of the following:

(a) Your portfolio is lousy.

(b) Your portfolio is diversified.

(a) “Lousy portfolio” happens fairly often. Unfortunate. Perhaps there are some excessively high-cost funds dragging the performance down. Maybe the portfolio is really a bet on a given sector or on some macro thesis. Or perhaps it’s more a bet on a handful of stocks. Maybe it’s a beta play in a down market. Or you’re way overweight tech and it’s 2022 and rising interest rates crushed you. I don’t know. There are all sorts of lousy portfolios. We encounter plenty of them.

(b) “Diversified portfolio” is common as well. Perhaps your benchmark did well over a particular time period and some of your holdings didn’t do quite as well. Maybe your benchmark is US large cap stocks (S&P 500) and you have an allocation to international stocks that didn’t fare so well over a given time period. It is not a bad thing, it is just diversification. One good, albeit simplified definition of diversification is owning some stuff that is currently underperforming. A cruder definition is owning some stuff you presently hate.

Psychologists discuss a cognitive bias called the fundamental attribution error. It is our tendency to attribute other’s behavior to their character while attributing our own behavior to our situation. If someone cuts you off in traffic you conclude it is because they are a jerk. If you cut someone off, you have a good reason. The fundamental attribution error.

I would like to submit the investor’s fundamental attribution error: every investor I’ve met automatically attributes the underperformance of their portfolio relative to a benchmark to possibility (a) my portfolio is lousy rather than (b) my portfolio is diversified. This can create some problems. The investor’s natural reaction to underperformance is that changes need to be made. This is a good conclusion if the underperformance can indeed be attributed to (a) lousy portfolio, but it is quite a bad reaction if the underperformance is the result of (b) diversified portfolio. If you blow out a diversified portfolio due to underperformance you will probably take the proceeds and invest in the stuff that’s performing well. Sell low, buy high. You had a diversified portfolio, but you thought it was a lousy portfolio. So you made some changes and now you do actually have a lousy portfolio. Congratulations! 

One simple method of increasing a portfolio’s diversification is adding exposure to companies domiciled outside the U.S. You hear terms like “global” and “international” in the investing world. There are all sorts of successful companies outside the United States – Taiwan Semi (obviously foreign), Anheuser-Busch InBev (you didn’t know that was foreign, did you?*), Toyota, Samsung… The U.S. market only makes up 60% of the global equity market, restricting the U.S.-only investor from 40% of the world’s businesses:[i]


It is commonly accepted among portfolio managers that a globally diversified portfolio is more prudent than an all-U.S. portfolio. There are some that disagree, but they are the minority. Global diversification exposes you to a broader range of companies, increasing the likelihood you own the best performers. It also decreases your portfolio’s risk – a globally diversified portfolio will be more protected against an economic downturn in the U.S. where a U.S. – only portfolio is completely exposed. Modern theories of portfolio construction emphasize uncorrelated assets. There is a reasonably low degree of correlation between U.S. and foreign equity markets, making global stocks a good diversifier.

Suppose we create a globally diversified two-fund portfolio that reflects overall market capitalization – 60% U.S. companies and 40% international companies. We’ll use the S&P 500 (the common benchmark by which portfolios are measured these days) with a 60% weighting for our U.S. exposure and the Vanguard Total International Stock Index with a 40% weighting for our non-U.S. exposure. We’ll name this the “Global Diversified Portfolio (GDP).” Rather simplified, but this gives us a reasonable proxy for a globally diversified portfolio. Importantly, it’s certainly more diversified than merely holding an S&P 500 index fund. That’s the whole point of the 40% international allocation.

Compliance disclaimer – you cannot invest directly into an index and an investor’s results will differ from those shown below due to trading costs, expenses, taxes, etc.

During the second decade of the 2000s, the Global Diversified Portfolio returned 11.07%/yr. while the S&P 500 – the benchmark – performed 13.55%.[ii] It is a real bummer to watch your globally diversified portfolio chronically underperform the S&P 500 for a decade. 10 years is a long time! The GDP only beat the S&P 500 on an annual basis during two (2012 & 2017) of those 10 years. Globally diversified investors watched their annual return lag the benchmark in 2010, 2011, 2013, 2014, 2015, 2016, 2018, and 2019. Given 60% of the GDP is the S&P 500 itself, the ~2.5% annualized underperformance of the Globally Diversified Portfolio over the decade is 100% explained by having a more diversified portfolio. Investors were told they should be diversified, so they diversified, and then the S&P 500 basically spent the last decade flipping them the bird. Most misattribute this underperformance to (a) lousy portfolio. The Investor’s Fundamental Attribution Error.

Let’s rewind another ten years. The first decade of the 2000s is referred to as the Lost Decade in investing circles. The S&P 500 index closed on Dec. 31, 2009 lower than it opened on Jan. 1st 2000. The S&P 500 investor lost money over a ten-year period. Brutal. But the Global Diversified Portfolio made money. Granted, not a lot of money. But not a negative number. Here is what it looked like:[iii]


Look, I am not trying to get you excited about earning 1.07% over the course of a decade. But certainly it is better than losing 9.1%?

Let’s expand diversification a bit further than simply global companies. Here is the performance of U.S. large cap (S&P 500), U.S mid cap (mid-sized companies - S&P 400), U.S. Small Cap (small companies - S&P 600), and international stocks (using the index mentioned above) during the “Lost Decade:”[iv]

Perhaps the “Lost Decade” wasn’t so lost for the diversified investor? Seems to me if you had an allocation to international stocks along with small and mid-sized U.S. company stocks, you did just fine. It was just a “Lost Decade” for the S&P 500 investor. Hopefully ten years of underperformance didn’t sour too many people on the S&P 500. Here are the same indices over the following 13 years (ending 12/31/2022):[v]


So the S&P 500 was the loser for the 1st decade of the 21st century. Diversified investors felt (relatively) good. Then it was the winner for the next 13 years. Diversified investors felt (relatively) bad. Many attribute their portfolio’s underperformance relative to the benchmark lately to lousiness when the primary reason has been diversification. Will the S&P 500 continue winning over the next decade and notch a full quarter century of dominance? I don’t know. But I’m not going to make that bet. I’ll avoid the investor’s fundamental attribution error. I’m going to stay diversified.

One does wonder how many investors threw in the towel on their U.S. large cap holdings after the “Lost Decade.” Negative total returns after ten years while small, mid, and international indexes provided positive returns. Certainly there was a temptation to trim their large cap exposure or tilt towards small/mid cap or something ostensibly harmless like that. How many advisors, sick of large cap’s drag on portfolio returns, recommended their clients do just that?

How foolish does that look now, 13 years later?

How many are now tempted to get rid of their recently underperforming diversifying asset classes in favor of the S&P 500?

How will they feel in 10 years?  

Sean Cawley, CFP®

*I didn’t either until a few days ago.


Neither asset allocation nor diversification guarantee against investment loss. All investments and investment strategies involve risk, including loss of principal.

Content here is for illustrative and educational purposes only. It is not legal, tax, or individualized financial advice; nor is it a recommendation to buy, sell, or hold any specific security, or engage in any specific trading strategy. Results will vary. Past performance is no indication of future results or success. Market conditions change continuously.

This commentary reflects the personal opinions, viewpoints, and analyses of Resolute Wealth Management. It does not necessarily represent those of RFG Advisory, clients, or employees. This commentary should be regarded as a description of advisory services provided by Resolute Wealth Management or RFG Advisory, or performance returns of any client. The views reflected in the commentary are subject to change at any


[ii] YCharts, Total Return Chart, SPX & Global Diversified Portfolio (as described above), 01/01/2010 – 12/31/2019.

[iii] YCharts, Total Return Chart, SPX & Globally Diversified Portfolio, 01/01/2000 – 12/31/2009.

[iv] YCharts, Total Return Chart, SPX/MID/SML/VGTSX, 01/01/2000 – 12/31/2009.

[v] YCharts, Total Return Chart, SPX/MID/SML/VGTSX, 01/01/2010 – 12/31/2022.