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YESTERDAY, I MADE the case for investing heavily in foreign stocks. Were you convinced? Many investors aren’t. They feel there’s no need to venture abroad. Here are three key arguments for keeping your stock portfolio close to home:
No. 1: The U.S. market provides adequate diversification.
Proponents cotend that, on their own, U.S. stocks offer all the diversification that an investor needs. U.S. shares represent a majority of global stock market capitalization, there are some 3,500 stocks to choose from and large U.S. companies provide significant exposure to foreign economic growth.
True, it’s possible that the U.S. could suffer a long period of terrible stock market returns, similar to Japan. The $64,000 question: Could this happen while foreign stock markets continue to fare well? Probably not. Foreign economies are highly dependent on the U.S., so it’s hard to imagine how our problems (or whatever caused them) wouldn’t affect overseas markets.
No. 2: The U.S. has been a better place to invest—and that’s likely to continue.
Proponents cite two key reasons to favor U.S. stocks. First, history tells us that U.S. shares have performed better. Yes, as fans of foreign stocks rightfully point out, overseas shares have beaten U.S. stocks in three of the past five decades. But that doesn’t tell the whole story.
How so? It leaves out the early part of the 20th century, when U.S. stocks beat foreign stocks in almost every decade. In addition, it doesn’t capture the margin of victory. When the U.S. dominates, it handily outperforms foreign shares—and, when it loses, it typically loses by a relatively small margin. Indeed, over the period through year-end 2019, U.S stocks outperformed foreign stocks over the trailing five, 10, 15, 20, 25, 30, 40 and 50 years.
To be sure, the fact that U.S. stocks delivered better results in the past doesn’t mean that’ll continue. That brings us to the second reason to favor U.S. over foreign stocks: America’s future continues to look brighter.
According to proponents, the U.S. remains a more attractive place to invest because it has significant advantages. We’re talking here about the U.S. political and economic system, the business environment, the legal system, rigorous stock market regulation and financial reporting, demographics, technological innovation and productivity. An added bonus: U.S. stocks don’t expose American investors to currency risk.
Meanwhile, the 10 largest overseas developed markets comprise 85% of foreign developed market capitalization. In order of size, these markets are Japan, the U.K., Canada, Germany, France, Switzerland, Australia, South Korea, the Netherlands and Hong Kong. Businesses operating in these countries are often hindered by restrictive laws and regulations, a less business-friendly economic system and policies, stagnant or shrinking populations, aging populations, less technological innovation and greater barriers to trade.
Japan deserves special mention because it’s a major position for many foreign stock funds. From its 1989 peak of some 38,900, the Nikkei index plummeted to 25,000 in 1991, as the Tokyo market bubble burst. But even after that initial precipitous decline, the Nikkei remains mired today at around 23,000, below 1991’s level. Why? Japan’s biggest problem is demographics. It not only has the world’s oldest population, but also its population is shrinking. That inhibits economic growth and puts severe fiscal pressure on the government. There’s nothing to suggest this situation will change soon.
Meanwhile, the six largest emerging market countries make up 82% of emerging stock market capitalization. In order of size, these six countries are China, Taiwan, India, Brazil, South Africa and Russia. But as with developed foreign markets, emerging markets are hampered by a slew of problems. Companies are often hindered by issues like totalitarian governments; business environments marked by great uncertainty, fraud and corruption; inferior legal systems; weak stock market regulation and lax financial reporting; a lack of technological innovation; and steep trade barriers.
Like Japan, China warrants special mention, because it accounts for a huge portion of most emerging market stock funds. Investing in China is likely to be profitable over the long haul, but it’s also accompanied by significant risk. The Chinese government has complete control over the financial markets—and it can do whatever it wants. Chinese companies have a history of issuing large numbers of new shares, thus diluting the stake of existing investors. On top of that, U.S. shareholders may get treated badly if things get ugly between the U.S. and China.
No. 3: Bogle and Buffett are pro-USA.
Warren Buffett is intellectually brilliant, an investment genius and a font of common sense. Similar praise has been heaped on the late Jack Bogle. Both are on record advocating that U.S. investors stick close to home. It’s difficult to ignore their views.
Rick Moberg is the retired chief financial officer of a publicly traded software company. He has an MBA in finance, is a CPA and has a passion for personal finance. Rick lives outside of Boston with his wife. His previous articles include Venturing Abroad, Six Tips and Give Me Five.
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Yes, and reason number 3 is certainly more than valid. On a similar note, I finally threw in the towel on trading individual stocks, etc., when I realized that someone maybe named Buffett , was taking the exact opposite side of my trades. When I am in doubt about investing, I will try to emulate Buffett, on a much smaller portfolio, to put it mildly.
Despite some international stock indices doing well recently, I remain aligned with Bogle and only invest in US based stocks. This approach provides plenty of international market exposure and has worked well during my 40 years of investing.
Rick – thanks for two really interesting articles. I struggle with this decision all the time. I’ve kind of ceded the decision to Vanguard, keeping around 20% in their total international fund. I’ve toyed with dropping the allocation to 10%, but haven’t. I suspect I’ll never feel completely comfortable with this aspect of my portfolio.
Rick – Two really good articles. Best I have seen in a very long time.
When there isn’t enough information to come to a definite conclusion (which is true of so many aspects of investing), I pick something reasonable, and stay with it. I believe investing is less about doing anything brilliant, and more about avoiding the big & costly mistakes.
Our portfolio attempts to isolate high return segments of the market while offsetting the higher risk to some degree at the same time (despite the truism that in a bear market, equity correlations tend to collapse to 1). Only time will tell if it works, but the US/Foreign stock ratio just kind of fell out of the result, and we’re about 55%/45%. The past ten years have been all about US Large Cap it seems, but the portfolio still did well enough (I figured the worst case scenario would still be fine), and I’m happy to let it ride.
You write that US stocks don’t expose American investors to currency risks. But they do. Anytime a US company buys inputs from or sells product abroad, it is exposed to currency risk. It isn’t obvious always, unless you pay attention to annual reports and analyst comments.