A year ago, we were in the throes of the Trump tariff rollout, which the financial media assured us was a serious economic threat. More recently, the Iran War has dominated headlines. The New York Times has drawn parallels to the 1970s oil shocks. If I told you a year ago what we'd be in for, you probably wouldn't have been very optimistic about the future.
Yet stocks have had a strong start to 2026, despite some choppiness in March. US small value stocks—typically our largest stock asset class holding—are already ahead of their long-term +13% per year average. The last 12 months have been particularly good, with a diversified stock portfolio more than tripling its long-term average, and several asset classes gaining more than 40%.
So what is going on? Either the market is completely clueless about the underlying economic and geopolitical developments over the last year, or something other than current events is driving stock prices.
Of course, it's the latter.
In response to questions about the potential market impact of the Iran War, Dimensional Fund Advisors examined all geopolitical events that occurred between the first Gulf War in 1990 and 2025. Over these 36 years (excluding the Iran War), they identified 21 distinct events, ranging from wars to terrorist attacks to currency crises. That's almost one event every 18 months!
If current events drove stock prices and market returns, wouldn't we see detrimental effects during this period, when geopolitical shocks occurred almost as often as annual holidays?
Not only have the now 22 geopolitical events had no lasting impact—the S&P 500 Index gained +11% annually from 1990 to 2025—but they also didn't have much of an effect in the short term, either. In the five days after a geopolitical event, stocks were basically flat, down 0.2%. In the following month, six months, and a year after, stocks on average gained +1.7%, 6.4%, and +14.6%, respectively. Does it make any sense for you to keep worrying about financial headlines and geopolitical shocks when the evidence is so clear that they don't tend to move the market needle?
If not current events, then what moves stock prices? Answer: Corporate earnings and how much investors are willing to pay for them.
The US stock market has appreciated 11.7% annually over the last decade, ending in 2025. Where did that return come from? According to Dimensional, US companies grew their earnings at a 7.6% annual rate—they've consistently provided goods and services at profitable prices that you and I are willing to pay for. The rest has been due to investors paying increasingly higher prices for companies, as price-to-earnings ratios have grown by almost 4% per year. The reason international stocks haven't done as well? Not because of earnings—non-US companies grew their earnings at a rate of 6.8% per year, but investors are still paying the same price-to-earnings ratios they did a decade ago. US stocks got more expensive; non-US stocks didn't. But they have all grown, and shareholders have benefited.
Think back over the last decade—tariffs haven't mattered, wars didn't matter, Covid didn't matter, and even high inflation didn't matter. Earnings mattered. So your investment focus shouldn't be on current events, but on earnings.
How best to do that?
Favor stocks over bonds.
When you own stocks, you have an ownership stake in a company. Earnings growth accrues to you in the form of price appreciation and dividends. Bonds are a loan you make that provides you with an interest rate and return of principal (absent a default) at maturity. The investment difference has been extraordinary.
From its inception in 1973 through March 2026, the Bloomberg Intermediate Government/Credit Bond Index has returned +6.2% per year, and $1 invested has grown to $24. But the Fama/French US Stock Market Index returned +10.9% per year over that same period, growing $1 to $248, over ten times as much.
Emphasize the right stocks.
Owning a share of every single US stock—indexing—has clearly been a great investment. But some segments of the stock market, or asset classes, give you more earnings exposure and higher expected returns. You can do better if you know where to look.
Higher-priced "growth" companies tend to have high earnings, but their prices are the highest in the market. Value companies, on the other hand, have lower earnings but the lowest prices. In buying value stocks, you don't get as many earnings per share, but you pay much lower prices, so you can afford more shares and could eventually achieve more earnings overall. Think of value investing like drafting a bunch of 2nd-round-skill players in the 5th round, rather than growth investing—getting a mid-first-round talent but having to spend the top pick.
Value and growth returns have played out as you'd expect—from 1973 to 2026, the Fama/French US Large Value and Small Value Indexes have had much higher returns than the market, +12.9% and +14.7% per year, respectively, while Fama/French US Large and Small Growth Indexes have earned market returns or worse, +10.8% and +8.1%, respectively. Adding large- and small-cap value stocks to a broad market index is another smart way to boost your earnings potential.
If paying less is a good way to earn more, so is buying companies with higher earnings and profits for a given price or asset level. Companies that can earn more on their assets and have higher profitability also tend to outperform low-profitability companies and the market. From 1973 to 2026, the Fama/French US High Profitability Index returned +12.1%, the Low Profitability Index just +8.2%. The market index owns both types of companies, which is not ideal.
Balance Is Best
Pulling this together, the asset classes we would want to emphasize in a US stock allocation are a Large Cap High Profitability strategy (as opposed to a traditional large-cap or large-growth index), along with Large Value and Small Value strategies. These core asset classes all have higher expected returns than the market and complement each other. International stocks make sense as well, but for simplicity, I'm just focusing on US stocks in this article.
Is breaking a US stock allocation down into a trio of asset classes really worth it? I'd say so. A 30%-30%-40% blend of the above indexes returned +13.7% per year from 1973 to 2026, 2.8% per year more than the market. $1 grew to $926, almost four times the market index's growth. A blend of asset classes also provides a better balance. When the US stock market lost -0.4% per year from 2000 to 2009, dragged down by the dot-com stocks that came to dominate the market, the 30-30-40 US Asset Class Blend not only didn't lose money, it almost doubled in value, gaining +6.3% per year. No serious investor would own index funds if they understood it was possible to do much better with asset-class investing.
I often give the same response to clients and prospective clients when they ask about the day's headlines and how they'll impact us—I have no idea what will happen, but I don't think they'll have a material impact. Indifference can sound like a naive or lazy response, but hopefully you can see that it's anything but that. I know, and you now know too, what will drive your investment returns, and you can see that we've made the right decisions to maximize those returns.
All we have to do is not intervene and let the earnings growth and return compounding work for us.
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Source of data: Dimensional Fund Advisors; Dimensional Returns Program.
Past performance is not a guarantee of future results. Index and mutual fund performance include reinvestment of dividends and other earnings but do not reflect the deduction of investment advisory fees or other expenses, except where noted. Indexes and mutual funds shown are for illustrative purposes only and may not be the only or any of the funds that Servo clients hold. Servo did not manage client portfolios for the entire period shown. This content is informational and should not be considered an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.