Staying Home

Adam M. Grossman

A UNIQUE EVENT occurred earlier this month: A group who call themselves the Bogleheads held an investment conference in the Philadelphia area, near the headquarters of Vanguard Group. Since its inception in 2000, this annual gathering has brought together fans of Vanguard’s founder Jack Bogle, who died earlier this year. 

Bogle was beloved by his fans for his authenticity and iconoclastic views. He was so self-assured, in fact, that—after he retired from Vanguard—he didn’t hesitate to share his opinions, even when he was in the minority and even when he disagreed with Vanguard’s official position.

Among the points on which Bogle disagreed with Vanguard was the question of international diversification. For decades, until the end of his life, Bogle was consistent in his view that investors need not—and probably should not—diversify their portfolios outside the U.S. Bogle said that his own portfolio was 100% domestic and he recommended that others do the same.

Vanguard’s official position, on the other hand, is that investors should structure their portfolios to pretty much mirror the overall makeup of world stock markets, of which U.S. shares currently account for somewhat over half. For instance, on its website, Vanguard recommends that investors allocate 40% of their stock portfolio to international markets.

In Bogle’s view, there was no need for international diversification, because the U.S. is “the most innovative economy, the most productive economy, the most technologically advanced economy and the most diverse economy.” To the extent that an investor desired exposure to foreign markets, Bogle pointed out that domestic companies derive such a large part of their revenue—more than 40%—from outside the U.S. that it was unnecessary to buy the stocks of foreign companies.

“If you own a domestic stock fund, you already own an international fund,” he said. Bogle also highlighted a number of risks, including currency depreciation and more limited shareholder protections outside the U.S. For all these reasons, he said, “I don’t do international.”

Vanguard’s official view, on the other hand, is based on the logic that investors shouldn’t exclusively favor one country’s stock market just because that’s where they happen to live.

My view: I believe international diversification is useful, but I absolutely worry about the risks that Bogle always cited. Even Vanguard’s own data indicate that a large majority of foreign stocks’ diversification benefit can be achieved with an allocation of just 20%, which is why that’s what I recommend.

I’ve been thinking about this more in recent weeks, as the protests in Hong Kong have raged and as the NBA has found itself mired in controversy, just because the general manager of the Houston Rockets issued one tweet that Chinese authorities didn’t like. Even after deleting the offending tweet, the financial fallout for the NBA has been painful.

These events reinforce my view that, though the U.S. is hardly perfect, our economic system is much less imperfect than many others. And this is why I’m happy to limit exposure to international stock markets—and especially emerging markets, where constraints on individual freedoms and government economic interference are both commonplace.

Still, I wouldn’t recommend taking your international allocation to zero. Earlier this month, The Wall Street Journal described how the consumer market in China has changed in recent years. Owing in part to improvements in domestic brands, as well as to growing patriotism, Chinese consumers have moved in large numbers away from foreign brands. Over the past 10 years, for example, foreign smartphone manufacturers have lost a mindboggling 78 percentage points of market share in China. Today, Apple is down to just 9% market share, while four Chinese vendors dominate with a combined 84%.

The implication for investors: Owning stocks in American companies may no longer provide sufficient diversification. In the past, it may have been enough to own companies like Apple, Nike and Hershey, since each had such broad international reach. But if they’re at risk of having their wings clipped outside the U.S., and particularly in China, you may want to broaden your portfolio to include their Chinese competitors Huawei, Li Ning and Three Squirrels.

No question, I share Jack Bogle’s concerns about international markets. But for the benefit of your portfolio, I recommend dipping a toe into foreign stocks.

Adam M. Grossman’s previous articles include Happiness FormulaYet Another Reason and Peter Principles. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.

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3 years ago

Adam, I probably split the difference between your allocation and Bogle’s 0%, for the reasons you both cite. Large American-based companies are essentially functionally multinationals, and while clearly imperfect I’ll take my financial chances with the SEC over pretty much any other country.

Langston Holland
Langston Holland
3 years ago

Most of us have been at this for a long time and have been well rewarded by sticking with the US in its position as the strongest economic engine in the world. It’s been a decade since foreign markets outpaced the US and it may seem a distant memory, but there’s more to it than that. Investing in US companies that derive much of their revenue outside the US is not at all equivalent to directly investing in foreign markets.

Vanguard for the past 5 years or so has recommended 30% foreign debt and 40% foreign equity to the US investor as the ideal. This is based on the math which they write about better than anyone else I’m aware of. Math doesn’t make an investor, as Bogle himself demonstrated, but IMO, in this area, his child has outdone him.

If you have the time and interest, there’s a 50 minute video that’s a good introduction to Vanguard’s reasoning behind their foreign allocation recommendations. Click here and scroll down to “The benefits of global investing” link.

Their research papers are second to none and this is a great introduction to the subject.

Finally, this is a thorough justification behind their foreign investment emphasis. Easily my favorite source to date on the topic.

Bottom line: 10% – 15% of foreign equity allocation will do the lion’s share of risk reduction for your portfolio. 20% is a bit better and 40% appears optimal.

Food for thought: how would you handle a period of significant foreign outperformance such as we saw in the 2000’s, and mid-80’s, and early 70’s and late 70’s? We seem overdue for a repeat.

Joe Tillman
Joe Tillman
3 years ago

Jack Bogle in his latter years said owning 20% international was okay.

Roboticus Aquarius
Roboticus Aquarius
3 years ago

There are as many opinions on this as investors. For me, the decision was by default. I built my portfolio on a set of assumptions (not a Boglehead 3 funder, but mostly low fee index funds). The Int’l portion was a simple outcome of that portfolio structure, at a tad over 40%. I decided I could live with that, and I have, despite the US outperformance this decade. Global is likely to bounce back at some point, and if it doesn’t, my returns are ‘good enough’.

I am not a fan of foreign bonds, no matter the purported benefits. They are not ‘riskless assets’ along the lines of MPT. US Treasuries, Short or Intermediate, are my choices. I have held EM bonds in the past, but I treated that as part of my ‘equity’ portfolio for purposes of measuring risk/volatility.

David J. Kupstas
David J. Kupstas
3 years ago

I assume international markets are not perfectly correlated with the U.S.’s. That being the case, I like having some international exposure. If the dollar gets weak, your international funds will get a nice bump.

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