Many American based investors have a common belief that investing in American stocks gives them enough world diversification because American companies do business overseas. Or even worse, they are using recency bias as an excuse to not invest directly in international stocks – because the American stock market has outperformed in the last 10 years. Fortunately, most investors understand that diversification reduces risk and generally provides most to generous long run returns. However, many Americans are not as diversified as they should be for example a Vanguard study on how their customer base invests found that the average international allocation for investors was around 19%. However, this is still lower than the typical recommendation from Vanguard which recommends a market weighted international stock allocation or between 40-50% for maximum volatility reduction. But the relatively low international diversification calls into question, why don’t investors invest more into international stocks?

Benefits of International diversification

  1. Lowered Volatility

                The main benefit in international stocks compared to a home country is lowered volatility in a portfolio. If an investor desires stocks but has a slight desire for less risky and less volatile allocations, a globally market capitalization is one way to achieve this. Using this graphic from Vanguard, visually shown here is how much of a reduction in volatility that can be achieved with a market weighted allocation as opposed to any single country – and the reduction in volatility is even greater if you live outside of America.

volatility

Source: Global equity investing, Vanguard

As we can see, historically a global weighted equities allocation has less volatility than any single developed country.

Another way we can visually show the volatility reduction is by comparing the expected reduction in volatility based on a percent allocated to non-home markets.

Source: Global equity investing, Vanguard

Depending upon your home country, a globally weighted allocation can make the most sense. However, there’s benefits for Americans from around 35%-45% international. Generally speaking, the market weighted capitalization should be a guide and perhaps not your specific pick. However, there’s more than just one reason to invest internationally.

  1. Rotating winners and losers

Even though the last ten years American markets have out preformed the rest of the world, during 2000-2010, international stocks out preformed the American market. And in fact, most of the out performance of American vs the world is pretty cyclical – Meaning it switches off fairly regularly.

Source: Global equity investing, Vanguard

American stocks have been a decent bet within the past ten years. However, taking a look historically non-U.S. stocks have also outperformed American stocks fairly regularly. And if we break this down on a country-by-country basis from 1999-2018 from the MSCI world index of the 23 developed countries. We find that rarely is America ever the best country to be invested in at any given year.

Source: Fisher Investments

This chart shows that no single country is ever the top preforming country for very long. And as such, investing in international markets can help reduce risk and keep returns consistent from year to year. Not only this but investing internationally keeps risks spread across an even larger number of companies, currencies, industries, and geopolitical climates. We can think about investing globally as a way to diversify risks related to regional politics, natural disasters, changes in a country’s underlying economic conditions, or other unexpected events. By investing internationally, you reduce the risk to your portfolio that if given a natural disaster that cripples the American tech industry, that your returns will still be relatively stable.

In today’s world, some of the fastest growing and largest companies are not located in America. America does make up a significant portion of certain sectors like technology – some of the largest materials and distribution companies are outside of America. The broader you choose to invest the more you could diversify your sector risk, size, and single country risk. You can still experience dips in your investment portfolio, but the ride is likely to be smoother and more comfortable with an international allocation, as opposed to a single country index might provide.

But if you’re looking to invest in a global index fund I’d recommend using VT – Vanguard Total World Stock ETF or if you simply want a bit more international stocks but don’t want a market weighted capitalization like VT, try using VXUS – Vanguard Total International Stock ETF (it excludes American stocks). But of these funds can be accessed using m1 finance (you’ll get an extra $10 dollars with the referral link) it’s a great platform for long term investing. And finally, if you’re looking for further ways to enhance returns check out our high risk and ultra-high risk newsletter.

Note: the m1 referral link gives the reader $10 extra dollars to invest with if they choose to fund a taxable with $100 dollars within 30 days of opening the account or fund an IRA with $500 within 30 days of opening an account. The author of this article will receive a $10 dollar compensation as a result of the reader opening an account. The compensation for both parties occurs 30 days after the deposit occurs and assumes the full amount is retained in the account until the end of 30 days from the deposit day.

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