No greater financial sage than Warren Buffett, CEO of Berkshire Hathaway, opines that investors should mostly stick to a low cost S&P 500 fund made up of the largest public US stocks. John Bogle, founder of mutual fund behemoth Vanguard, also eschews the benefits of international investing. This advice comes in spite of Vanguard’s billions invested in international stocks.
As if these financial titans weren’t enough to sway you from international investing, stock performance in recent years adds fuel to the domestic bias fire. From 2013 to 2016, there wasn’t a single year that international developed markets performed better than the S&P 500.
After years of not keeping pace with the S&P 500, investors are naturally asking whether to keep it simple by investing in US stocks exclusively. In my mind it still makes sense to invest a portion of your stock portfolio in diversified international funds. Consider these reasons.
International stocks still offer vital diversification. Harry Markowitz won the Nobel Prize in part for proving that holding different assets that do not perform in sync with each other can result in a superior portfolio than just holding a single asset. International stock markets do not perform the same as US stocks. Recently we have seen the negative side of this difference, but there have been extended periods when the US stock market has not kept pace with the world, particularly the years 2000 through 2009.
Watchful market observers may say that international diversification is overrated as we observed in 2008 when broad world market indices plunged more than the S&P 500’s calamitous performance. While it’s true that in the short-term there are few advantages in investing internationally, the benefits of diversification kick in once you become a long-term investor.
What have you done for me lately? Because international stock markets have not been performing as well over the last few years as the US stock market, the logic is that this divergence must persist. This bias would have you flock to the asset class that has done the best in the hope that it will do the best. Unless you have a fundamental belief that economies in other countries over future decades will not keep pace with ours, then you should invest in stock markets that have not done as well as ours.
International values may be better. By some measures, the U.S. stock market has appreciated to the point that it may be considered overvalued compared to its peers. One of the key ways we assess value is looking at the earnings of the companies and comparing them to the price of the stocks. The average P/E ratio (price earnings ratio) is less in international developed markets than in the US. This means we have to pay more for company earnings in the U.S. than overseas. This could portend better performance in international markets than in ours.
Let’s say you agree that international investing is a good idea. The question then becomes: how much? Vanguard published a study in 2011 that concluded that optimal portfolios have between 30 and 40 percent of stock investments in international holdings. Another analysis by Dimensional Fund Advisors stated that a 70 percent U.S. stock and 30 percent international stock portfolio was superior in over 80 percent of 10 year overlapping periods.
Out of all of your stock investments, look at the range 20 to 40 percent for your international allocation. Start with 20 percent if you’re new to international investing or feel more comfortable keeping closer to US stock market performance. Gravitate toward 40 percent if you think international markets are riper for superior performance.