The Smart Take:
How much money do you have in international investments? How much should you have? Listen to Kevin discuss what the science of investing says and why you are likely underallocated to international markets. And be sure to listen to the end where he shares a story of a recent conversation with a new client related to international investing.
Prefer to read? See below for the transcript of the show.
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The Host:
Kevin Kroskey – About – Contact
Introduction: 00:03 Welcome to Retire Smarter with Kevin Kroskey. Find answers to your toughest questions and get educated about the financial world. It’s time to Retire Smarter.
Walter Storholt: 00:16 Another great podcast coming at you today on Retire Smarter and I mean it’s going to be a good one today. Walter Storholt here alongside Kevin Kroskey, President and Wealth Advisor at True Wealth Design serving you in Northeast Ohio, with offices in Akron and Canfield. Find us online at TrueWealthDesign.com. Don’t forget to subscribe to the podcast on your favorite app. If you want to get in touch with the team, we’ll tell you some ways that you can do that a little bit later on in today’s show. Or just check the description of today’s show notes for that info as well. Kevin, you ready for another great show today?
Walter Storholt: 00:46 Let’s do it. Walter, let’s dive in.
Walter Storholt: 00:49 We’ve got a lot to get to today. And I think this subject, if anybody saw the headline about investing internationally and some of the reasons to do so, in fact, three specific reasons why you might want to do that is an interesting topic because this is something that I’ve always kind of wondered Kevin. I feel like, okay. I kind of know about US businesses. I feel like I have a good grasp or handle on what’s happening in the US economy, but my mind would start to spin if I start thinking about investing internationally.
Walter Storholt: 01:18 Yet I feel like I’m only exposing myself to a very small piece of the pie if I focus domestically. But that’s also what I know. And I’ve also kind of heard the terms or the guidance to focus on what, you know, when you invest, right? Don’t get into the spaces where you have no idea what you’re doing. So I kind of have this conflict of there’s a big opportunity out there to invest worldwide and internationally, but at the same time trying to stick to that principle and invest in what you know. So I’m interested to hear your guidance today on this topic because it kind of hits close to home and will you be opening my eyes to some possibilities here?
Kevin Kroskey: 01:51 Well Walter, I tell you what, I appreciate you sharing what you just shared and if you harken back to how we started our podcast together. And I did though retirement rules gone awry series, the saying that you know, invest in what you know, well that you certainly want to understand your investments but these sayings or these roles will often kind of lead you astray or maybe not tell the whole story. So I think maybe we’ll kind of go down that path today as well. And, and I should note that what I’m referencing, there was an article, at Vanguard I came across a couple of weeks ago and I kind of elaborated on this put my own spin to it. And then they did have, you know, really three reasons why they invest internationally was the topic of their article. And I really think two are pretty much different ways to say the same thing.
Kevin Kroskey: 02:39 So we’ll see how our title at that point, I actually when I actually launched this, but if somebody looks at the title and said, Hey, you forgot number three, well, well that’s why. So let’s dive in if you will. But Walter as you kind of answered already. The world’s a big place, right? And when you look at kind of US investing and outside of the US, US today comprises about 55% of the total investable universe in terms of, you know, publicly-traded stocks. And so, you know, that’s a pretty big portion, you know, 55% back. You know, a decade ago it was a little less than half. So, depending on how good the US is doing relative to international markets, you’ll see this, you know, 55% kind of ebb and flow. And certainly, if you went back decades, the US would have been a bigger portion. But where we are here now, today in 2019, it’s about 55% and then when you go outside of the US obviously you have 100% total.
Kevin Kroskey: 03:34 So 100% minus 55% is 45% and you can further divide that 45% between developed and developing or also called emerging markets. And emerging markets today are roughly about 10% of the total. So just to kind of look at it overall, you have 55% in the US you have 10% in emerging markets, places like China, India, Brazil, and then you have the balance or 35% in international developed outside of the US so our friends to the North end, Canada, European Union countries, Japan, Australia. So those are the biggies right there. And so that’s what the market is. And when you look at today, you know, in large part we are in a global financial world. So you have companies like Toyota or Samsung that may be headquartered outside of the US but a big portion of their business is still inside the US where you have some US-based companies that you know, sell around the world, McDonald’s, Google, what have you.
Kevin Kroskey: 04:39 And so you have some of these companies that they’re worldwide. But nonetheless, you also have some of these smaller companies within each of these countries that are more exposed to the domestic economy. So, while you’re kind of looking at the world, so to say, and you are thinking about this role or the saying that you referenced Walter about, Hey, invest in what you know, there’s a big part of the world that’s out there that you know that you may be avoiding. And we’ll talk about some of the reasons why you may not necessarily want to do that.
Walter Storholt: 05:10 Well, I know I’m going to have to go back and listen to one of those first episodes that we did about those retirement rules gone awry. I’m glad I could trip up there and you, and you catch me and be like, Hey, go back and listen to that episode. Remember, not all sayings are worth following. So, I’ve just got to say, as a side note, I’m kind of blown away. Even though you said it used to be bigger in the past, I’m kind of blown away by 55% of the world market essentially is the United States. That just still seems like such a big chunk. It’s hard to wrap your mind around that.
Kevin Kroskey: 05:39 It’s a big chunk, but it’s also, you know, we have definitely bang kind of the bastion of capitalism or at least the purest form of capitalism. That’s been around for some time. So, yeah, so that’s where we’re at. I mean, if you look at it a different way in terms of like GDP, I mean, it would be different. I mean, China becomes much more prevalent in a, in a kind of measurement like that. But if we’re just looking in terms of the investible universe, publicly-traded equities, and that’s how it shakes out. So the thing that you mentioned about kind of investing in what, you know, there are these things in basically, this is how our brain works, but our brains applied to investing, they’re called different investing biases. And so what you just paraphrase was, Hey, invest in what you know or what people would call, let smart academics, that study of the brain and brain science and behavior, they would call that the familiarity bias.
Kevin Kroskey: 06:34 So things that you know tend to be more comfortable, less fearful. And so that’s what I’m going to go ahead and invest in. It could be US Stocks, it could be, and that specifically has it’s own name called “home country bias”. People in the US tend to have a higher portion of their portfolio in US stocks. Canadians tend to have a higher portion of their portfolios in Canadian stocks. Australians, well, same thing. And you can kind of go around the world and, and you see that same phenomenon happening. I had a client meeting earlier today and he is a physician that works at CVS and he’s like, Hey, I got this employee stock discount program and I can go ahead and buy CVS stock for a discount of price. You know, should I do that? And I feel good about it for these reasons. And you know, he’s stating reasons and he’s familiar with the company, right?
Kevin Kroskey: 07:24 And he works there. And so you know, he’s just more familiar with it. So owning stock inside of your employer plan or the company you work for, you know, inside of your 401k plan and what have you. Again, there’s tends to be a familiarity bias that you have there and also relates to being overconfident a lot of times. So these are things, and it’s just how our brain works and so things that we need to be mindful about. So really what I want to do over the remaining part of the podcast is just kind of peel back the onion a little bit and really look more about the evidence and really what makes sense in terms of investing science and you know, having international diversification or not. So the first part of that, and again these were kind of referenced in this Vanguard paper, but I can elaborate on a little bit, but call it diversification or risk reduction benefits.
Kevin Kroskey: 08:11 And the way that we often measure that, I’ve kind of called it this before on the podcast, but call it a kind of a wiggle factor. You know, how much variability do you have in your returns per year? Mathematically we call that standard deviation, but it’s really about you know, how much your portfolio returns are going up and going down your values, your dollars are going up and going down. And what the Vanguard study has shown, and I’ve seen this, you know and done in other studies over the years and the result has been pretty consistent, but when you have about 40% of your money outside of the US, and again these are all using kind of, you know, diversified indices. It’s not like you’re picking specific companies to go and invest in. It’s just kind of investing in broad global indices is how these studies are constructed.
Kevin Kroskey: 08:58 But if you have 40% of your money outside of the US one if you’re 100% in stocks, it would be 60% in the US then historically the volatility or the wiggle factor would have been minimized. And you can actually break it down further. You know, if you have fear an all-stock investor or if you say more of a balance, like 60/40 stock and bond investor, then the percentage maybe a little bit different and actually a little bit higher than 40% if you’re that more balanced investor that I just mentioned. So 40% may sound like a lot. And if for the people that are listening right now, it probably does sound like a lot particularly, you know, if you’re doing this on your own, you know, because of that home country bias, because of that familiarity bias, I can’t really recount may be more than one or two people over the years where I’ve looked at their portfolio when they came in and we first started working together that they really have more than like 10% or 20% in international investments.
Kevin Kroskey: 09:56 So, you know, certainly the home country bias was quite strong in that case. But the science of investing, which shows that, Hey, you know, I should probably have, you know, two to four times that 10% or 20% to really reduce the volatility. Really reduce the risk and why would we want to do that? Well, if you have less volatility, you have the smaller wiggle factor, ultimately you tend to have higher compounded returns over time. So the example that I always liked to give here is, and Walter, I put you on the spot with this several episodes ago and I’ll set you up for success and do it again. Your buddy said you did so well in the last one, but let’s suppose that we start with $100 in year one and we lose half of our money?
Walter Storholt: 10:42 50, I got it, right? 100%, we’re done, right?
Kevin Kroskey: 10:43 All right, so what percent return do we need just to get back to even in year two,
Walter Storholt: 10:45 We would need a 100% return to get back.
Kevin Kroskey: 10:58 You got it. So you go from a $100 down to $50 to get back to $100 you need a 100% return in year two. And if you do that, your compounded return, which is kind of what we can eat if you will, is zero. And because you just got back to square one. But if you look at your average return, you get a minus 50% return in year one, you get a 100% return in year two. You add those two together and is 50, you divide it by two years and you get an average return of 25% well, you know, you’ve got an average return of 25% that may sound great, but you got $0 in terms of dollar growth and that sort of volatility that we just kind of went through in that example that Walter, you crushed it yet again on a good job, you know that volatility matters.
Kevin Kroskey: 11:41 And so if you have a smaller standard deviation if you have smaller wiggle factor and typically you’re going to have more dollars over time, certainly for the same average return, you’re going to have more dollars. And where that particularly matters is when you’re on the second half of the game and in retirement and pulling out money in terms of doing your portfolio, distribution, planning, doing your income planning and making sure your money lasts. If you have a lot of wild swings and you’re pulling from that money and don’t have safe money to pull from, then you know, ultimately you could get very, very unlucky. And that’s not a good thing to have to happen when you’re in retirement. So the volatility reduction, again, higher compounded returns, all else being equal and certainly helps in terms of the distribution planning. And when, if you back up for a minute and just think of kind of economics, I mean you have, you may have these big multinational companies that around the world today, you know they have production facilities in different parts of the world, but a lot of times those companies, they hedge their currency risk.
Kevin Kroskey: 12:40 You know, Toyota wants to go ahead and they don’t have to worry about how the Yen is moving to the dollar to the Euro. So a lot of times they’ll just say, look, we’re in the business of making and selling cars. We’re going to hedge away this foreign currency risk that we can’t control. So let’s just go ahead and do that. And when you have a multinational company that is hedging your foreign currency risk, then you’re kind of taking away some of the diversification benefits as if you would’ve otherwise, you know, invested in that foreign currency. So you know, the fact that you have different economic cycles, you have different fiscal and monetary policies, different currencies even have different sector weightings. You know in the US you have a much, much more technology in health care. You go over to Europe and you have a lot more kind of old school industrials and what have you. Then you don’t have the big, you know, a technology sector that we do here. Emerging markets, you have more of a technology sector. So you know, all these markets are different. And so even though you know the world is increasingly becoming a smaller place and more integrated, you certainly can continue to pick up diversification benefits by investing in these different countries.
Walter Storholt: 13:44 Well, I know this is, it’s kind of a big concept, right? This we were talking to international markets versus domestic. I mean we’re not talking necessarily here about, you know, the most simple of investments or one particular tool. We’re talking about entire classes and angles and countries being involved here. So maybe it’s hard to give this just like a symbol story to sum it all up. But, and I also know that we have to guard against that, you know, that term, maybe this was in one of our past episodes, we’ve talked about this, that mentality of past performance can’t predict, you know, future returns, that sort of idea. But can we look into the past to see where these different allocations for folks that may be panned out in a positive way or also in a negative way if they weren’t, you know, kind of internationally spread out. If there have been past examples that have shown us the importance of investing internationally?
Kevin Kroskey: 14:32 Yeah, that’s a great question. Walter and I had a meeting recently and so this was a, a client that we did some planning for oh probably six, seven years ago. And then they came back and kind of want to work together on an ongoing basis at this point. And one of the questions that we were talking about it was, you know, how the was going to be invested and we’re kind of talking about it at a high level cause we first need to update their planning. But, but we talked, we’re having this similar conversation about international investing in, and the husband made a comment like, Oh that it’s never really worked out well for me. And I asked them, well, how come? And he just intimated like, well, you know, when I look at the 401ks, you know, the international markets had the lowest returns.
Kevin Kroskey: 15:17 And I said, well, you know, Paul, how long have you been investing in these markets and how long have you even been investing in these 401k plans? And he said, well, you know, Hey, my wife and I, we met in the late eighties and I’ve kind of been handling the investing since we got together. And you know, we’ll really be paying a lot of attention to it, you know, for the last 10 years or so since we got into our 50s and got serious about retirement. I said, well, Paul, what happened, let’s go back a little bit further than let’s say the last 10 years. During the last 10 years have been phenomenal to be US investor in investing in US markets, you know, kind of post-global financial crisis, 2009 actually international markets did a lot better than the US but really since then say for a year or two and the US returns have been better than international returns.
Kevin Kroskey: 16:04 And so I said, Paul, you know, if you’ve only been making in attention for the last 10 years or so, I mean, if we go back, you know, say the prior decade, you know, what can you tell me about returns back then? He said, well, I mean, I had kids. I was working a lot. I didn’t have nearly as much money. And so I wasn’t paying as much attention. I said, well, I mean, have you ever heard of the phrase the last decade? And when I explained, I said, you know, when you look at what happened in the 90s with the tech bubble kind of growing and growing and you know, these technology stocks and growth stocks do really well. And then really 9/11 was, was the catalyst to kind of accelerate the downturn after the markets had ballooned. And really that bubble was bursting starting in 2000 if you are investing in US markets and just S&P 500 for an entire decade, for 10 long years, you lost money over that entire 10-year period.
Kevin Kroskey: 16:57 And you know, he was just quiet. And I said, well, you know, I mean, you own that stuff. You probably don’t just as much if not more of it back then than what you do today, but you just weren’t paying attention to it. And he kind of nodded his head, but you know, and I’ve had a similar conversation with several people, but it’s really kind of time-dependent and you’ll look at different periods of time and you’d go back to that last decade, international markets were going gangbuster, you know, back then in large part, I honestly see just international markets, but the currency kind of moved favorably. So when you brought money back over from overseas, you’re getting more us dollars. And so, the kind of currency was really a tailwind for US investors. And so, you know, it happens. You don’t know exactly when the US or international markets are going to do better.
Kevin Kroskey: 17:44 Certainly there’s forecast that you can make out on that on one here in a moment about what Vanguard is saying. But nonetheless, I mean, particularly when you’re approaching into retirement and you need to make sure that your money’s going to last, you don’t necessarily want to put it all just on one country. You know you want to spread the risk a little bit, you know, whether it’s 40% or 30% or 20% you know, something that’s going to make a difference is probably what you’re going to want to do. And doing, you know, just a couple of percent or 5% really isn’t going to slice it, but you want to go ahead and you want to spread that risk and there’s going to be some periods of time where the US is going to do better in some periods of time when the international markets are going to do better.
Kevin Kroskey: 18:23 So you want to probably have a target. What we do here, I mean we have a target, the 40% is our benchmark, but we have some latitude to circle as much as you can, going down to as little as 20% international diversification or as much as 60% which is really, you know, kind of, we’re a little bit more in alignment with the overall kind of a global view, if you will. And there’s been periods of time where we’ve been substantially overweight the US and times more so like today where we’re the other way and we’re kind of favoring the less expensive asset classes that are out there and particularly in these international markets. So, you know, we talked about being dynamic on a prior podcast about your allocation. You always have to kind of understand the history and you have to have some targets, but then you probably need to have some flexibility to go ahead and move to wherever the puck is likely to be over the coming five or 10 years.
Kevin Kroskey: 19:13 And when Vanguard went through a process like that recently, and again in the same article that I reference, I won’t give the exact returns, but what they’re saying is over the next 10 years, they expect international markets to return on average about 3% more than the US and so if you have, you know, 10 years at 3% per year ignoring compounding, that means that international market investments per Vanguard’s expectations are going to grow 30% more than the US. And I can tell you, we did a prior podcast on a similar topic and kind of relayed an article from Morningstar and Christine Benz and she really did a survey of a lot of different money managers and their expectations and they were all pretty uniform and none of them are going to get the numbers exactly right in terms of whether it’s, you know, 8.2% or 5.1% but if you get the ranking right, if international markets are going to do better than the US and you favor international markets, then your allocation or your investing recipe is going to end up more right than not.
Kevin Kroskey: 20:15 And so that’s the thing that I think you’d have to think about, particularly where we’re at today. US market disproportionally has done, you know, much, much better, you know, say over the prior 10 years or so and it’s gotten a lot more expensive. And so the basic tenant of investing is to buy low and sell high. You also want to make sure that you’re diversified. So these are things that come into the equation, particularly today when you’re evaluating that. How much do I want to own domestically in the US versus internationally? And of course, it gets more kind of complicated than that, you know? Well, if you make that decision while what within those markets do you want to own? Do you want to own value stocks for growth stocks or small stocks or big stocks or sectors or what have you. But generally speaking, when you’re looking at these asset allocation decisions of saying stocks or bonds, US or international, that’s really going to explain the preponderance of the return that you’re going to get over the coming period.
Kevin Kroskey: 21:06 Certainly you want to have a good prudent process, but you know, you get to a point of diminishing returns over time. So I guess what I would say to kind of sum it up here is, you know, you really want to pay attention and say, look, you know, US market returns, I’ve probably owned a fair amount of them in my portfolio. I’ve done it. Wow, that’s great. I’m happy about that. But it is really likely to go ahead and do a repeat 10 years from now that domestic markets are going to do the same thing in relation to international markets. You know, might it be better to go ahead and make sure that I am, you know, more properly diversified, reducing the volatility, being able to facilitate, you know, kind of these higher compounded returns and facilitating better distribution planning for my retirement years and thinking a little bit more globally than just kind of in my own backyard, which we’re all predisposed to do. It’s just the way that our brain works, but you’re going to think that way initially. My hope is then we’re going to have a more rational conversation about really outside of that bias that we all have, what’s the right decision going forward?
Walter Storholt: 22:06 That’s just kind of another example too, of not putting all of your eggs in one basket. That’s one of my takeaways here, Kevin is just making sure that you’re not ignoring this opportunity that’s out there to invest internationally and putting everything into the US basket. It’s a good idea to be diversified beyond just that one country, that one area to keep your funds.
Kevin Kroskey: 22:25 Yeah. I mean if you are only in the US going through the 2000s and if that were to repeat then you know, literally you’re going to lose money for an entire decade. I don’t think we’re there. I’m not saying that we are, but it’s possible. And if that happens in retirement that could be ruinous. You know, if you’re in your 40s or 50s and you’re still working and you’re not paying close attention like Paul probably wasn’t over the last decade, then you know, Hey, you can always work longer. Right? But you know, for most people that’s not necessarily a good strategy. We would just want to have an eyes wide open approach. We certainly want to pay attention to investing science. We want to go ahead and maintain proper diversification. And though when perfect, you know, there are ways to go ahead and estimate where future returns are likely to fall and we want to favor those things are likely to do better for us.
Walter Storholt: 23:09 Well, if you have questions about anything we’ve talked about today when it comes to investing internationally if it’s something you’ve done before and maybe don’t understand why you’ve done it, I know that that’s the case with a lot of people who, not just this particular example, but just in general, why do we get into certain investments? Always good to get clarity on that, but also if you just have kind of ignored the opportunity or never considered it, but you’re kind of realizing that lack of diversification that’s available to you and you want to talk it out with a member of the True Wealth Design team, you can certainly do that. Oh, you have to do is go to TrueWealthDesign.com click on the “are we right for you button” and schedule a 15-minute call with an experienced financial advisor on the True Wealth team or you can give a call to (855) TWD-PLAN if you prefer that method. That’s (855) TWD-PLAN. Kevin, thanks for all the help given us these reasons to invest internationally. Great information today and we’ll look forward to talking to you again soon.
Kevin Kroskey: 24:03 Sounds good, Walter, and I’ll leave it with one more concrete thing. If you look at your portfolio and you have less than 20% internationally, I would say in my opinion, you probably have a portfolio problem.
Walter Storholt: 24:13 That breaks the entire 30 minutes down into pretty simple a takeaway. Thank you very much. That’s Kevin Kroskey. I’m Walter Storholt. Hope you enjoyed the show. We’ll be back with another great topic next time around. So, join us again back here on Retire Smarter.
Disclaimer: 24:35 The information provided is for informational purposes only and does not constitute investment, tax or legal advice. Information is obtained from sources that are deemed to be reliable, but their accurateness and completeness cannot be guaranteed. All performance references historical and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fees.