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IT’S AN ARGUMENT I’ll never win. But perhaps I can sow a few seeds of doubt.
The anti-foreign-stock drumbeat has grown louder with each additional year that international markets underperform U.S. shares. Indeed, even though foreign stocks beat U.S. shares in the 1970s, 1980s and 2000s, there are folks today who argue there’s no reason to own foreign shares.
Really? Before you throw in the towel, ask yourself six questions:
1. If U.S. stocks had lousy returns for 15 years, would you abandon them? Since year-end 2009, foreign stocks have lagged behind U.S. shares almost every year. If U.S. stocks had served up that sort of mediocre performance, and I declared that it was time to give up on America’s publicly traded companies, readers would eviscerate me for my flip-flopping, failure to appreciate market history, and possible horrible market-timing—and the criticism would be richly deserved.
2. If U.S. multinationals are a good substitute for investing abroad, why don’t they perform like large-cap foreign stocks? Pained by international markets’ lackluster results, it seems many U.S. investors are looking for an excuse not to invest overseas.
One of their favorite contentions: There’s no need to own foreign stocks, because U.S. corporations offer ample international exposure. But if that were truly the case, wouldn’t returns for large-cap stocks in the two markets be similar? Yet, over the 15 years through Oct. 31, MSCI’s Europe, Australasia and Far East index has notched just 5.7% a year, far behind the S&P 500’s 14.2%.
3. Yes, foreign companies offer fewer legal protections and greater business risk. But isn’t this already reflected in share prices? Arguably, investors today are getting paid to take the greater risk associated with international markets.
For instance, the stocks in Vanguard Total Stock Market ETF (symbol: VTI) sport a price-earnings (P/E) ratio of 26, based on the past year’s earnings, versus 15.7 for Vanguard FTSE Developed Markets ETF (VEA) and 15.5 for Vanguard FTSE Emerging Markets ETF (VWO). That huge difference in P/E ratios tells you how much more comfortable investors are owning U.S. companies—and how much more room there is for foreign-stock valuations to rise.
4. If foreign stocks are riskier, shouldn’t they offer higher returns? Many in the anti-foreign-stock camp are trying to have it both ways: They’ll claim that U.S. shares are less risky—and yet they’re also confident that U.S. shares will continue to outperform. What happened to the notion that high risk and potentially high return go hand in hand?
5. If you’re an indexer happy to hold U.S. stocks according to their market value, shouldn’t you also be willing to allocate among countries on the same basis? Many—and perhaps most—HumbleDollar readers are index-fund investors, and most index funds weight stocks based on their stock-market capitalization. Today, for instance, that means having 6% of your U.S. stock market money in Apple and almost nothing in Bath & Body Works.
Yes, some carp that this weighting scheme leads to too much money in tech stocks. Still, despite that, I haven’t heard of many folks giving up on their S&P 500 or U.S. total market index funds. I have, however, heard countless folks say there’s no way they’d put roughly 40% of their stock portfolio in foreign markets, even though that’s what a market capitalization approach would suggest.
In designing my own investment mix, I take my cues from the so-called global market portfolio. Investors worldwide have collectively decided that foreign stocks should account for 40% of the global stock market’s value. Who am I to disagree? That’s why Vanguard Total World Stock Index Fund (VT and VTWAX) is my largest fund holding.
To be sure, that opens me up to the risk of both foreign stock and currency fluctuations. The dollar has strengthened in the foreign-exchange market over the past decade-plus, denting the performance of overseas stocks for U.S. holders.
Will that persist? Nobody knows. In fact, nobody knows what will happen to global stock and currency markets in the short-term—which is why I believe you should keep money you plan to spend soon out of stocks, and especially foreign stocks, and in nothing riskier than high-quality, short-term U.S. bonds.
But that doesn’t preclude owning international markets. Suppose you’re retired and have half your money in U.S. bonds and half in Vanguard Total World Stock. Result? Some 20% of your overall portfolio would be subject to the whims of the foreign-exchange market and foreign stock markets—an acceptable level of risk, I’d argue.
Can’t bring yourself to stash 40% of your stock-market money overseas? I’d strongly favor going for at least 20%. At that level, investors can get much of the reduction in portfolio volatility that comes with owning foreign stocks.
6. What if you’re wrong? Foreign stocks’ diversification benefit isn’t just about tempering a portfolio’s price swings. It’s also insurance against truly terrible results. You might be confident that U.S. stocks will continue to reign supreme, offering a magical combination of high returns and low risk. But what if you’re badly wrong?
I hate to bring up Japan’s 34-year market disaster once again, and yet I consider it the most significant financial event of my lifetime. What if, in 1989, you were a Japanese investor who was so convinced of your home economy’s strength that you had 100% of your retirement money invested in domestic stocks? At the time, the Japanese economy was the envy of the world. Few foresaw the stock-market debacle that was to come.
Could a similar debacle await U.S. stocks? It’s unlikely. But low risk isn’t the same as no risk. Is it wise to bet your stock portfolio solely on the U.S. market? Many investors are doing just that—and it worries me.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on X @ClementsMoney and on Facebook, and check out his earlier articles.
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The notion of “American Exceptionalism” is driving lot of investors from around the globe to pile into US stocks. See link below: “U.S. companies now account for 70% of the leading global stock index, up from 30% in the 1980s, while the U.S. economy’s share of global GDP is just 27%”.
This could be creating a bubble.
https://finance.yahoo.com/news/mother-bubbles-us-sucking-money-215345592.html
“Investors worldwide have collectively decided that foreign stocks should account for 40% of the global stock market’s value. “
To be an obnoxious nitpicker, that is probably incorrect. If a stock holder in say Germany has 40% in foreign stocks,
“foreign” includes US stocks.
So they would have 60% in German stocks, and 40% in all other countries,
including the US.
Add up all the 95% non US people in the world, and I doubt if there would be 60% in US stocks. 🙂