By Paul Ohanian, CFP® & Thomas Doellman, PhD
Academics and industry professionals have known for some time that when people invest in the stock of publicly-traded companies, they tend to invest in companies from their home country. Known as the “home country bias,” this behavioral bias is one of many that plague individuals’ retirement investment portfolios. The reason? Diversification…or lack thereof!
Importance of International Diversification
Diversification aims to mitigate risk. By adding more and more investments to a portfolio, one can achieve the same expected return on their portfolio while taking on less risk. Put differently, it strives to help investors achieve the best possible return for the level of risk they are willing to take. And while U.S. companies constitute around 55% of the total value of publicly-traded companies globally, that means there is still ample opportunity to capture the diversification benefits of investing in companies outside of the U.S. But, on average, U.S. investors are not taking advantage of this opportunity.
According to an annual report put out by Vanguard each year (“How America Invests 2020”), just over 80% of U.S. investors’ stock portfolios were invested in U.S. companies. Of course, this percentage would be much closer to 55% if individuals held a globally representative stock portfolio – more evidence of that pesky home country bias.
It Might be Time to Take a Fresh Look at Your Portfolio
Given the incredible run in the U.S. stock market over the past 12 years, now may be just the time to consider how diversified your portfolio truly is. Taking a fresh look at international developed and emerging markets may be just what your portfolio needs.
Recent Performance Advantage of the U.S. Stock Market
Some may point to the performance advantage the U.S. stock market has experienced over the past several years as justification for this bias. And it is true that U.S. companies have outperformed more recently. In fact, the U.S. market outperformed an index of international developed markets 9 out of 10 years from 2011 to 2020; however, during the 10 years prior (2001 to 2010), the U.S. outperformed in only 3 years. And if we take a long-run view over the past 50 years, the U.S. has outperformed exactly half of the time. Thus, from a performance perspective, history suggests a need for global diversification as well. But this performance argument is potentially flawed regardless. Again, diversification is more about ensuring you have an optimal investment portfolio. By not taking advantage of international diversification, investors are not optimally controlling for the risk within their portfolios.
The U.S. Stock Market has become Top-Heavy
A more recent trend in U.S. markets may highlight further need for international diversification. Due to the outsized performance of the “FAANG” stocks (Facebook, Apple, Amazon, Netflix, and Google) in recent years, the U.S. stock market is historically top-heavy. This suggests that an investment portfolio dominated by U.S. stocks will be overly sensitive to a handful of large U.S. technology companies. A globally diverse portfolio can provide the necessary diversification to ease this sensitivity.
Scottsdale Wealth Planning, Inc. (“SWP”) is a registered investment adviser. Advisory services are only offered to clients or prospective clients where SWP and its representatives are properly licensed or exempt from licensure.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
Asset Allocation may be used in an effort to manage risk and enhance returns. It does not, however, guarantee a profit or protect against loss. Diversification does not ensure a profit or guarantee against loss. Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations.
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Originally published March 2021 in The Town of Paradise Valley Independent.