Many years ago, I worked in a Euro-Mex restaurant. Fed up with the dominance of Tex-Mex, the Mexican and Dutch restaurateurs wanted to introduce a new cuisine blending the best of both culinary worlds. Think cheese. Lots of cheese. While the restaurant did well, its food fell short of the best Mexican restaurants.
Meeting with investors over the past year, I’ve learned that many of you would be fine stripping your investment portfolio of any euro flavor.
The market has taken a welcome siesta from its turista of the last few months. Major indices such as the S&P 500 and the Dow Jones Industrial Average have reached multi-year highs. Perhaps what’s most soothing is that the rise has come in a very steady, unflappable way. The VIX index, which measures volatility in the U.S. market, reached its lowest level in more than five years.
What’s the cause behind this languid prosperity? You have to wonder whether it has to do with Europe being on holiday. This last month we’ve seen few stories about German Chancellor Angela Merkel prodding Spain, Greece and Italy to reform their budgets. It seems without the external shocks in the form of euro sovereign debt crises, that the world markets prosper.
Truth is that many of you believe that investing internationally is a poor idea — at least right now. Why don’t we wait until the euro crisis normalizes and Italy and Spain are on stable ground?
You might think international diversification is overrated. With increasingly globalized markets, international and domestic markets often move in sync. Splitting your eggs between international and domestic baskets may have been wise before, but perhaps we’re just taking on a lot more risk without the upside of holding investments that don’t bottom out at the same time.
Certainly you can find recent data to support this idea. The U.S. market had its worst year in decades in 2008 with the S&P 500 down 37 percent. The MSCI EAFE Index of large companies in other developed countries didn’t offset this plunge. It piled it on with a 43 percent loss that same year. “Deworsification” may seem to be the appropriate descriptor of using international investments.
Let’s look a longer timetable — from 1970 to 2011. The S&P 500 had a total return averaging 9.8 percent annually, while the EAFE was up 9.6 percent annually. But if the U.S. market has done better over time, maybe investing internationally still doesn’t make sense. Why would I accept weaker performance and in return get an asset that’s subject to the euro imbroglio that could resurface next month?
Just like peanut butter cups, it turns out that two great things combined can make something altogether better. Consider an all-equity portfolio made up of 70 percent S&P 500 and 30 percent EAFE indices. Every year, you rebalance back to those same ratios. Careful readers of this column know that rebalancing is a systematic way to buy low and sell high.
This mixed portfolio had 10 percent annual returns in the same period, with less risk than either index alone. While this improvement may be modest, once you start adding in emerging market funds and other asset classes you have the makings of an even better performing portfolio.
But your gut may still tell you to liquidate your international holdings. Before you do, just consider: Are you just selling low? By the time everyone is sanguine about the European economy, it may be too late to benefit from the gains.