First off, I realize no one cares about this thread and it's basically a personal blog. Given no one reads any of this, my plan in the near future is to start posting erotic fan fiction about the moderators. Their selfless dedication to making GRB a cool place to hang out heightens my desire to defile them.
Anyway, I digress. Today I want to post some random thoughts about international equities. This post is for anyone who is skittish about investing international or would like to understand the benefits of international equities investing better.
The Case for International Equities
It's totally understandable that someone might be skeptical about investing internationally. In the last 40 years US index funds have performed much better than international. Here's a chart that illustrates that fact:
Domestic has routed international. However, there's several reasons why I think international equities diversification is still a very attractive option to any portfolio:
1) Japan has been a huge drag on international performance. In the late 80's Japan's stock market valuation was higher than the US. So if you purchased an international index in the late 80's and 90's you were mostly buying Japanese stock. Today Japanese stocks
represent about 17% of an international index. In essence you don't have to worry as much about one country tanking the index anymore. More on Japan later.
2) In the past 5-10 years international index fees have gone down significantly. For example,
Vanguard's total international has a 0.11% expense ratio which is very reasonable.
3) Portfolio diversification. Let's get back to Japan. Here's the horror story of Japan's stock market in one graph:
Japan still hasn't recovered from its high in the 80's. Now you may look at this graph and think to yourself this is why I don't want to invest international. However, I take the opposite view. There's no rule that says this type of performance can't be the US in the future. I'm not saying it's likely, but it is possible. That's why diversification is powerful/important for any portfolio. International equities gives you significant diversification if the US market tanks like Japan.
Now, some will argue "big US companies do a lot of business overseas so I'm basically diversified in international". However, a
Vanguard white paper shows that the correlation isn't as high as most people imagine (figure 2). Additionally, you'll be missing out on industry weighting:
Lastly, a portfolio made up solely of U.S. firms, which are more concentrated in biotechnology, computer equipment, information technology and IT services, and software, would be underweighted in “old world” industries such as electrical equipment, durable household goods, and automobiles. In other words, an all-U.S. portfolio would lose not just investment opportunities but also the diversification benefits of a portfolio that’s more evenly distributed across industries.
4) Another concern with international is currency fluctuation risks. However, the same
Vanguard white paper demonstrates long term currency fluctuations do not materially impact equities prices and actually help with diversification (page 12).
5) I hesitate to post this last point because it's slightly a market timing thing, but here we go...
Valuations for US equities are historically high right now. It's worth noting, valuations are only a good predictive factor of market returns in the long term (10+ years) and have little correlation with returns in the short term (< 3 years). However, if you are planning to keep your money invested for a long time it doesn't hurt to be aware of valuations. For instance, take this graph:
Higher CAPE means higher valuations. CAPE for the S&P 500 is currently ~31. In non-US developed markets it is roughly 20. CAPE isn't a perfect measure, but if historical patterns hold, it is more probable that we will see higher returns in the next 10-15 years from non-US markets.
How to Add International Equities to a Portfolio
As I've posted in the past I'm a big fan of the simple
3 fund portfolio. It's how I invest. That said, even if you don't utilize a 3 fund portfolio adding international equities exposure is conceptually easy to do. My recommendation is to add 20-40% international equities to your overall equities exposure with a
low cost index fund. According to Vanguard, 20% international equities gives you over 80% of full diversification benefits. 30% is 99% of full diversification benefits. 40% is almost full market weighting.
Here's how international equities weighting works in practice (I arbitrarily added 20% bonds, however your allocation might/should be different):
20% (Over 80% of full diversification benefits)
80% Equities
20% Bonds
80% Domestic Equities
20% international Equities
That means for every 100 dollars you invest it should have the following allocation:
Equities - $80 (domestic vs international allocation formula below)
.....80% Domestic Equities -
$60 = 80 * .8
.....20% international Equities -
$16 = 80 * .2
Bonds - $20
30% (Over 99% of full diversification benefits)
80% Equities
20% Bonds
70% Domestic Equities
30% international Equities
That means for every 100 dollars you invest it should have the following allocation:
Equities - $80 (domestic vs international allocation formula below)
.....70% Domestic Equities -
$56 = 80 * .7
.....30% international Equities -
$24 = 80 * .3
Bonds - $20
40% (almost full market weighting)
80% Equities
20% Bonds
60% Domestic Equities
40% international Equities
That means for every 100 dollars you invest it should have the following allocation:
Equities - $80 (domestic vs international allocation formula below)
.....60% Domestic Equities -
$48 = 80 * .6
.....40% international Equities -
$32 = 80 * .4
Bonds - $20
Summary
Investing in international equities is something you should consider. Anywhere from 20%-40% ratio to your overall equities portfolio can provide significant benefits.
Let me know if you have any questions.
***Michael is not a licensed financial adviser and provides investment advice for entertainment purposes only. Not available in all 50 states. Void where prohibited.***