Why Only “Buying Local” When Investing Is Risky
Currently, U.S. investors may be asking themselves why they should be investing outside of their home country when their own stock market is doing so well. Just a few decades ago, U.S. investors were asking themselves the opposite question.
The third quarter of 2019 brought some very positive news for me on a personal level—I received my green card and am now a permanent resident of the United States. If that’s not enough to make me feel patriotic about my newly adoptive country, I needn’t look further than the U.S. equity markets to feel proud.
Over the past decade, the American stock market has been incredibly strong, and by some definitions we qualify for having the longest bull market in history.
For example, from September 5th, 2011 until September 5th, 2019, the total return of Vanguard’s VTSAX fund, which tracks the total U.S. stock market, was 252%. Vanguard’s VFWIX fund, which tracks world equity markets outside of the U.S., only had a total return of 58% over the same period.
Why invest in international stocks?
A natural question after hearing this statistic might be: why does Betterment’s portfolio have such a large allocation towards international stocks? After all, our 100% stock portfolio currently has a target allocation of around 40% in international equities.
The short answer is that the Betterment portfolio is designed to be representative of the makeup of global investable assets as a whole, and around 40% of the world’s equity assets are invested outside of the U.S. But an international portfolio can also reduce the risk of overweighting one particular country in your portfolio.
Home bias can lead to more risks.
Some investors choose to overweight their investments in their home country, which is a phenomenon known as home bias. Home bias can expose your portfolio to more risks as it gets less internationally diversified.
An especially gut-wrenching example of these risks occurred during this last quarter for Argentinian investors. Latin American investors tend to have strong home bias, with the average Latin American investor tending to allocate 97.5% of their portfolio to Latin American markets—even though only 1.4% of the global capitalization is Latin American.
An extremely high local stock market allocation may have been initially positive for Argentinian investors, because their markets grew over 40% in the first eight months of the year. However, on August 12, 2019, the MSCI All Argentina 25/50 Index fell over 24% in just one day. Currently, the index is now seeing overall negative returns for the entire year.
Source: Data from Xignite
This recent loss was a blow to Argentine equity investors, especially among those with a strong home bias. It’s worth noting that because Argentina and the U.S. are entirely different countries, we generally shouldn’t expect their markets to behave the same. While Argentina is a beautiful country known for its art, dance, food, mountains, and beaches—it’s also currently battling an extremely high inflation rate. The country is currently instituting currency controls to combat the devaluation of the Argentine peso.
True diversification helps equip you for the long haul.
It’s impossible to predict what will happen with the U.S. stock market going forward. But, we do know that historically, U.S. stocks have also seen long streaks of underperformance compared to international stocks. In the chart below, we plot the 2-year annualized returns of the MSCI EAFE index, which tracks the performance of international developed stocks, and the MSCI USA index, which tracks U.S. equities. Highlighted in gray is any period where international stocks outperformed U.S. stocks. Keep in mind that past performance is not indicative of future performance.
Source: Data from MSCI
Since the start of the indices, we see that U.S. stocks have outperformed international stocks about 57% of the time. However, until 1990, U.S. stocks only outperformed international stocks 32% of the time. At that time, U.S. investors may have been asking themselves the exact opposite question—why invest in American equities that are lagging international markets?
True international diversification means that your portfolio will never be the portfolio with the highest returns—but it will also generally be better equipped to handle local crises and downturns. We now live in a globalized world, and your portfolio at Betterment is designed not only to help avoid the risk of local downturns, but to capitalize on global growth over the long term.