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Diversification

Why You Should Invest Beyond U.S. Stocks

Your Betterment portfolio is internationally diversified. Here are three reasons why that’s essential for managing risk over time.

Articles by Dan Egan

By Dan Egan
Managing Director of Behavioral Finance & Investing, Betterment
Published: March 24, 2015 | Updated: July 22, 2018

Global allocation of capital is a good estimate for how an individual should allocate his or her own capital—subject to personal risk level.

While the S&P 500 is a core part of global stock markets, the U.S. is hardly the only stock market in which you should be investing.

One aspect of your Betterment portfolio that may differ from other investments is international exposure. Your Betterment portfolio reflects the entire global economy, by applying some of the most sophisticated investment research about asset allocation and diversification.

As this breadth of international exposure may be new to some investors, we’ll discuss three key reasons for why we provide it, and what it seeks to accomplish. (See where in the world you’re invested with Betterment.)

International exposure provides optimal diversification and manages risk.

Betterment uses an asset allocation method called the Black-Litterman model, which Fischer Black and Robert Litterman pioneered in 1992 when they were at Goldman Sachs. Their key insight was that the global allocation of capital is a good estimate for how an individual should allocate his or her own capital—subject to personal risk level.

This is the same model that many institutional money managers use, and industry experts consider it to be one of the best available models for ensuring well-diversified portfolios. (Learn how we applied Black-Litterman for our portfolio optimization.)

As such, a well-diversified portfolio helps you manage risk—meaning it reduces the extremes of your ups and downs, keeping you humming along in the center lane of performance.

In the chart below, we show rolling two-year returns of the U.S. stock market (light blue) and developed international stock markets (dark blue). The gray shading indicates a period of time where international markets beat domestic markets. As you can see, international wins about 50% of the time. With a diversified portfolio, you’re aiming for the middle of U.S. and international stocks. That doesn’t mean experiencing zero losses—it means getting average gains.

Domestic and International Returns

It reflects actual global capitalization for long-term growth.

It’s important to understand that for global stock markets, the United States currently makes up approximately 50% of total market capitalization, the bulk of which is represented by the S&P 500.¹

While the S&P 500 is a huge chunk, international stocks and bonds are playing an increasingly large role in portfolio investing as more and more economies grow to maturity around the globe. Think of countries such as South Korea, China, or India; these are the countries that are included in your portfolio in addition to the United States, providing opportunity for growth, even if (or when) the United States is slowing down.

It eliminates the dangers of home bias.

Lastly, the Black-Litterman model-based international exposure in your Betterment portfolio corrects for so-called ‘home bias.’ Home bias occurs when an investor overweights his or her portfolio to hold securities that are based in his or her country of origin. This happens because it’s a natural human tendency for people to avoid things unfamiliar to them.

Research shows that when we know the company names of stocks, for example, we are more comfortable with them, and we feel like we have more information about them. But that feeling is a kind of false comfort and leads to portfolios that are under-diversified—and thus will never get the best possible risk-adjusted returns.

For example, it’s easy to know you want a piece of Google in your portfolio, but you might not know that you should also have a piece of Tencent, China’s most popular Internet portal. Through your Betterment portfolio, you own a piece of both. Google is represented in the ticker VTI, and Tencent is represented in VWO.

While the S&P 500 is a core part of global stock markets, the U.S. is hardly the only stock market in which you should be investing. Our investment philosophy at Betterment is to provide a portfolio to manage both your downside risk as well as upside growth. The goal is to be consistent over time—so that you can rest assured you’re in a reliable investment that you can ‘set and forget.’

¹http://www.etf.com/ACWI

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