Why I Invest Globally (and think you should too)
They say diversification is a free lunch, but it sures feels hard. Here's my 'why' of global diversification.
Why I Invest Globally (And Think You Should Too)
As a financial advisor, I've always eaten my own cooking when it comes to my investment portfolio. I've maintained a broad allocation to global stocks, not just because I recommend it to clients, but because I truly believe in its value. However, I've noticed that investing in international stocks is consistently one of the items that gives my clients pause, especially when recent performance in US stocks has been so good!
Just the other day, after we reviewed his portfolio, a client had me walk him through the 'why' of international stocks. His questions and concerns are ones I've heard many times before, and I thought sharing my responses might be helpful for others grappling with similar doubts. Here's what I said in response to his questions:
The Big Picture: Don't Put All Your Eggs in One Basket
Imagine you only invested in businesses from your hometown. If your town faced an economic downturn, all your investments would suffer. The same principle applies on a larger scale when we talk about investing in different countries.
As Larry Swedroe, author and investment expert, puts it:
"...it's simply not logical for investors in every country to believe their home market is going to outperform. It may be patriotic, but it sure isn't rational."
The Challenge: Resisting the Allure of Recent Performance
One of the biggest hurdles in maintaining a globally diversified portfolio is resisting the temptation to chase recent performance. It's a common concern I hear from clients, especially given that the U.S. stock market has more or less outperformed international stocks since the 2008 financial crisis.
This impressive run, lasting over a decade, can make it tempting to go all-in on U.S. stocks. But here's the catch: even a decade is a relatively short time in the world of investing. Making decisions based only on recent performance is like choosing a football team based on their last few seasons – it doesn't tell the whole story.
Throughout history, we've seen numerous examples of market leadership changing hands:
In the 1980s, Japan was the star performer
In the 1990s, the U.S. took the lead with the tech boom
In the 2000s, emerging markets and international stocks outpaced the U.S.
Since the financial crisis, the U.S. has again been in the lead
Check out the chart below from Kitces.com. As you can see, there’s a sense that every decade or so, market leadership changes. Investing globally helps your portfolio navigate these secular shifts in market performance.
This pattern suggests that no single market stays on top forever. The challenge? It's incredibly difficult to go against the crowd and not chase recent performance. Our brains are wired to spot patterns and follow trends, which makes it tempting to invest heavily in whatever has been doing well lately.
As humans, we tend to:
Overvalue recent events (recency bias)
Seek the comfort of the crowd (herd mentality)
Fear missing out on gains others are experiencing
But remember: Past performance doesn't guarantee future results. This is especially true for recent performance!
Going against the grain and maintaining a globally diversified portfolio when your home market is outperforming takes discipline and a long-term perspective. It's not easy, but it's a fundamental principle of sound investing.
Why Should You Care About International Stocks?
It Can Make Your Investment Journey Smoother
Research shows that more diversification is better. It's like having a balanced diet for your money.
It Helps Avoid "Lost Decades"
Sometimes, one country's stock market can stagnate for years. As noted above:
In the early 2000s, when U.S. stocks were flat, international stocks performed well.
U.S. stocks were doing great when Japan's market collapsed in the early 1990s.
International Stocks Might Be a Bargain
Right now, international stocks are generally cheaper than U.S. stocks. In the investing world, this often means they have the potential for higher returns in the future.
It Spreads Your Bets Across Different Types of Companies
Different countries often specialize in different industries. By investing globally, you're not just betting on one country's economic strengths.
Putting Global Investing into Practice: Addressing Your Concerns
Here are some common concerns I hear:
“Isn't the U.S. the safest place to invest?"
While the U.S. has a strong economy, remember that some of the world's most innovative companies are overseas. Global investing lets you tap into growth opportunities worldwide.
“What about currency risk?”
Currency fluctuations can indeed impact returns, but they can work both ways. Over the long term, these tend to balance out and can even provide an additional source of diversification.
"How much of my portfolio should be international?"
This depends on your individual situation, but I generally suggest that 30% to 50% of my clients’ stock allocation should be international. Interestingly, when weighted by market capitalization, the current global stock market is about 60% U.S. and 40% international. This gives you a sense of how the global investment community values different markets1.
"What about the impact of global events, like the recent pandemic?"
Global crises underscore the importance of diversification. Different countries have handled challenges differently, leading to varied economic outcomes. A global portfolio helps spread this risk.
Remember, starting to invest globally doesn't mean making drastic changes overnight. You can begin by gradually adding international exposure to your portfolio. The key is to stay patient and maintain a long-term perspective.
The Big Picture
Imagine a seesaw with the U.S. on one side and international markets on the other. History shows that they tend to take turns being on top, usually switching every decade or so.
Final Thoughts
Investors often talk about not putting all their eggs in one basket, but I like how legendary investor Sir John Templeton put it, "To avoid having all your eggs in the wrong basket at the wrong time, every investor should diversify."
"To avoid having all your eggs in the wrong basket at the wrong time, every investor should diversify."
In these uncertain times, with rapid global changes and shifting economic powers, the case for global diversification is stronger than ever. It may not always feel comfortable, but in my experience, it's a crucial strategy for long-term investing success.
Investing internationally might feel unfamiliar or even risky. But remember, if something feels 'safe' in investing, it usually means lower potential returns. The perceived 'risk' of international stocks could be your opportunity for better long-term results.2
Always consult with a financial advisor for personalized advice tailored to your specific goals and risk tolerance
Remember, this is just an introduction to the topic. Always consult with a financial advisor before making investment decisions, as everyone's situation is unique.