U.S. stocks have significantly outperformed international stocks in recent years. And U.S.-based multinational companies are major players in the world economy. Yet, forsaking international stocks is not good idea.
U.S.-based investors generally favor U.S.-based investments. This has become known as home country bias and is not unique to U.S. investors. Canadians tend to own more Canadian companies. Germans own more German companies, etc. Simply put, we tend to favor companies we’re more familiar with and are in our backyard.
Yet, international stocks represent 44.9% of the global market—a figure too large to ignore. And diversification is the only free lunch in investing. By owning international stock investments, you can diversify your portfolio and take advantage of opportunities in other developed and emerging stock markets.
Changing Market Leadership
U.S. and international stocks often swap positions as performance leaders. Over the decade of the 2000s, dubbed The Lost Decade from a U.S. investor’s perspective, the S&P 500 cumulatively lost money over the entire 10-year period. International stocks substantially led the way.
What might the future hold as leaders potentially turn to laggards? Global diversification gives you a chance to participate in whatever region is outperforming at a given time.
Positive International Outlook
U.S. stocks have had a great run, but will that continue? From a U.S. investor’s perspective, the expected return outlook for non-U.S. stock markets over the next 10 years is 8.4%, higher than that of U.S. stocks at 5.1%. (Source: Vanguard Capital Markets Model®.)
Having a mix of international and U.S. stocks has historically reduced risk, as measured by volatility, in portfolios. Peak risk reduction has been shown to be achieved by having about 40% of your stock allocation in international markets, leaving 60% in U.S stocks.
It’s true that correlations have increased between U.S. and international markets as globalization has taken hold. However, including international stocks in your portfolio still carries diversification benefits because of differences in economic cycles, fiscal and monetary policies, currencies, and sector weightings. Further, smaller companies within each country are generally more exposed to their domestic economy. So, risk reduction benefits may be more pronounced by overweighting these companies.
Yes, the U.S. is a great country, and we are all fortunate to call it home. But this is no reason to exhibit home country bias, forsake global diversification and increase portfolio risk.
As a U.S.-based investor tuned into the 24/7 news and reporting on U.S. stock market indices, you will be prone to a home country bias. The rational investor in you, however, will realize U.S. stocks are just part of your prudently diversified portfolio. Though the U.S. will outperform at times, international stocks will outperform at other times. Combining the two in appropriate amounts will smooth out the investment ride over time.