Credit: Shutterstock photoInvesting in the stock market can be a frightening enterprise. One way that Investors may attempt to increase their comfort in the risky venture that is the stock market is by only investing in stuff they are familiar with - stocks like Alphabet Inc. (GOOG), Apple Inc. (AAPL), Netflix Inc. (NFLX) or Amazon.com Inc. (AMZN). However, such a strategy will likely catch the ire of most competent financial planners, who will advise diversifying you stock investments outside of the U.S.
Diversifying Beyond U.S. Stocks
Investing exclusively in companies you're familiar with means giving up diversification. And when you don't focus on diversification, you increase your risk. If you decide to submit to the value of diversification, it can mean investing in the entire U.S. stock market - all 3,000+ companies on offer. That’s sufficient diversification. And it can all be had at very low cost as well, via a cost-competitive index fund. (For more, see: The Importance of Diversification.)
But you canalso invest in companies outside of the U.S. Is it worthwhile to diversify your stock investments beyond the U.S.? At this point, the answer depends on which investment professional you ask.
John Bogle on International Stocks
Recently, I had the honor and pleasure of attending the 2017 Bogleheads Conference. The Bogleheads are a group of investors - professional practicing advisors and retail investors alike - who fiercely champion low-cost investing. The group is named for John C. Bogle, the founder of Vanguard Group, the first investment company to launch a true low-cost index fund and the industry leader in low-cost investing.
Bogle, the star himself, was at the conference and took time to answer myriad questions about investing. Given Bogle’s uncommon view on international stock diversification, it was inevitable that someone would ask for his thoughts regarding the need to include international stocks to increase the diversity of your investments. Bogle humored the audience, once again justifying why he thinks the only diversification you need is every single United States company and not a single one outside of the United States. I’ll do my best to summarize Bogle’s views here.
Challenging Growth Prospects for International Economies
The three biggest economies outside of the United States are the U.K., Japan and France - in that order, reported Bogle. Bogle holds less than optimistic projections for all of these countries. Here's a summary of his views:
- Brexit is Britain’s challenge to future excess growth. Bogle believes such a difficult transition will likely mute the country's growth prospects.
- Japan’s highly-structured society along with their decreasing birth rates gives Bogle confidence to forecast subdued economic growth.
- And finally, there is France, which has a tradition of strong government regulations on limiting the work week. This could also suggest only moderate economic growth potential relative to the U.S. economy. (For more, see: The Greatest Investors: John (Jack) Bogle.)
The Value of International Diversification
Another point Bogle makes is that although Apple, Google and Facebook may have their roots as U.S. companies, their reach is global. With so many U.S. companies earning revenue from international efforts, owning U.S. companies means effectively gaining exposure to international economies. The fact that certain U.S. companies have international business activities is undeniable. But are those business activities sufficient to show up in the returns in the U.S. stock market?
When attempting to answer this question, it is important to look at what has happened in the past. We can attempt to (at least partially) answer this question by looking at what has happened. Perhaps the most interesting time period to evaluate is the “naughties,” or the 10-year period between 2000 and 2009. During this time, the S&P 500 (as a measure of U.S. stocks) produced quite meager returns. The total return over the 10-year period was -3.25%, or an annual loss of 0.33% per year.
What value would international diversification add then? Let’s run the numbers and find out.
Instead of a negative return for the period, an investor who put some of their money in international investments was now able to eek out almost 2% per year over 10 years. That greatly outperforms U.S. stocks alone. Further, adding international stocks to a diversified portfolio and rebalancing that portfolio (selling what’s gone up in value and buying what’s gone down in value) in a disciplined manner may mean greater benefit than holding U.S. stocks alone.
However, such performance is most certainly not guaranteed. Extending the period past the naughties and through the end of last year changes the picture. Struggling performance of international companies meant less money for investors putting assets into international economies.
Perhaps the value of holding international stocks is not an increase in returns over time, but the chance to earn more money if the U.S. economy were to underperform over short periods of time.
Is Bogle Wrong?
Bogle’s argument is indeed compelling. Framed this way, it looks like there may be a strong case for holding U.S. stocks exclusively. Still, I can't help but wonder if Bogle could be wrong.
At the end of the day, the job of a financial planner is to put the client in the best possible situation for success. In my opinion, omitting half of the world economy as an investment seems risky, especially given some periods of performance in the past. For my own accounts, and for those of my clients, international economies are included. While others may disagree, we think including international stocks gives everyone the best chance at investing success. (For more, see: Diversification: Protecting Portfolios from Mass Destruction.)
This article was originally published on Investopedia.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
