This article was originally published in the Tacoma News Tribune April 1, 2014.
By Gary Brooks, CFP®
Imagine that you are limited to investing only in stocks of companies west of the Mississippi River. You would have access to many good companies from a variety of industries. But you would likely be uncomfortable with this limited investment opportunity.
Expand this example to a global scale, however, and this is close to the experience that many investors happily accept.
Vanguard, one of the world’s largest investment managers, collaborates with Spectrem Group to produce a quarterly survey of mass affluent and high net worth households to identify their preferences on many investment topics. In the most recent release of their findings, 74 percent of the mass affluent segment and 43 percent of the ultra high net worth investors indicated they were unwilling to invest outside of the United States.
When you consider the global investment marketplace, based on the total market value of all publicly traded companies, the international market is slightly bigger than the U.S. marketplace. If you invest only in U.S. stocks, you ignore half of the world’s investment opportunities.
The reluctance to invest abroad is driven by many factors even though analysis of past performance demonstrates that adding international investments to U.S. investments has provided the blissful combination of more return and less risk.
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The case for excluding international companies in your investment strategy has several clear supporting arguments.
Some would rightfully say that many U.S. companies generate plenty of their revenue abroad therefore you don’t have to invest in foreign companies to gain exposure to foreign markets and participate in the global economy.
Others suggest there is plenty of opportunity for diversification within U.S. stocks and the opportunity for solid returns is plentiful enough right here at home.
Fear of political instability, worry about business practices, or concerns about the effects of changing currency valuations could keep some investors domestically focused. Or maybe your definition of patriotism includes not investing in foreign companies.
There is validity in these reasons. And yet, it’s still difficult to comprehend how an investor who seeks real balance can ignore the other half of the investment opportunities available. What are the odds that the next great growth story, quality of life innovation, or simply underpriced stock will come from the U.S. when more than half of publicly traded companies are outside the U.S.?
Having a home-country bias is rational and demonstrated around the globe. Americans own more U.S. investments, Australians own more local companies than American investments, and so on.
The important question is, to what extent should you include international companies in your investment mix? You might say that it depends on the attractiveness of the alternatives at any given time. And there is some truth to that which may lead you to tilt one direction or the other, but trying to predict whether U.S. stocks or international stocks will outperform from one year to the next is a fool’s errand.
Since 2000 – we’ll call this the investment landscape of the modern global economy – the MSCI EAFE (Europe, Australasia, Far East) Index of developed international stock markets has outperformed the U.S. S&P 500 in eight of 14 years. Cumulatively over that time, there has been very little difference in the performance of the two indexes.
Vanguard researchers modeled various combinations of U.S. vs. international stock allocations over time. They concluded that generally 30 percent of your overall stock market exposure going to international companies, has been optimal. Given period-specific performance differences, there are years when 70 percent international stocks would’ve been best and others when 10 percent would’ve been best but over time, Vanguard points to a 30 percent target weight. If you are a 60 percent stock market investor, this translates to a combination of 42 percent U.S. stocks and 18 percent international stocks. This is a generic baseline condition. When one or the other appears to be trading at a better value, overweighting that option should be beneficial. Today, that would mean increasing international stock weight, perhaps shifting from 18 percent up to 25 percent and reducing U.S. stocks to 35 percent.
Of course, this is a guideline that has no basis in your personal risk tolerance or your current financial situation. There are many factors that should be included when determining how to best position your investments. This should also include consideration for international bonds as well as stocks. If you were to cut the global universe of stocks and bonds into a four-piece pie, international bonds would be the largest market in the world, representing 32 percent of the pie. International stocks would have a 24 percent slice, U.S. stocks 23 percent and U.S. bonds 21 percent.
Advancement of the global economy will continue to make investing abroad tougher to ignore in the future.
Gary Brooks is a certified financial planner and the president of Brooks, Hughes & Jones, a registered investment adviser in Old Town Tacoma. Follow him on twitter @moneyarchitects.