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 Formula, Yet 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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