When it comes to picking our favorite sports teams, most of us have a “home bias.” We tend to support and cheer for the teams local to us. We buy their gear and spend time watching them play. If we remain loyal to our teams, it can be an emotional rollercoaster! We delight when our team wins the big game or brings home the championship, but we sulk over a hard loss or a bad season. We are up when they are up, and we are down when they are down.
While there is certainly no harm in supporting our local sports teams through thick and thin, having a home bias when it comes to investing might not allow us to achieve the most out of portfolios. A home bias in regards to investing means over-allocating toward domestic companies or completely avoiding international investments altogether. Some might be tentative about foreign investments, but they can have a positive effect to your portfolio.
According to Vanguard, the United States accounts for about 58% of the total global equity markets. While this is a significant slice of the global markets, investors are locking themselves out of over 40% of all global equities if they invest exclusively in U.S. companies. Overseas companies include household names such as Nestlé, Toyota, Honda, Sony, and Samsung among many others.
Allocating a portion of a portfolio toward foreign investments provides an element of diversification to supplement domestic investing. Investing globally gains access to a wider collection of market and economic forces than an investor can find by merely owning domestic equities. For example, performance of domestic stocks versus international stocks tends to be cyclical. While U.S. equities have recently outperformed their foreign counterparts, that has not always been the case and will likely change at some point in the future. This chart shows the performance of the U.S. market and international markets between various economic cycle peaks.
Global investors also receive the benefit of currency diversification. Like stocks, the value of various currencies relative to each other fluctuates. In general, as the U.S. dollar increases in value relative to other currencies, the value of U.S.-based stocks increases relative to international stocks. But, this works in reverse also. As the value of the U.S. dollar decreases against other currencies, investors in international stocks tend to benefit.
While investing internationally does provide diversification, these same features can also carry unique risks including currency volatility, economic fluctuation, and political instability. Foreign stocks also tend to be more volatile than domestic equities. However, adding international exposure to an already well-diversified portfolio can actually reduce the overall volatility of that portfolio. A recent study by Vanguard showed that while the U.S. markets tend to experience the lowest volatility of any one particular country, a globally diversified portfolio of U.S. and foreign stocks experienced even less volatility over a long time horizon. The diversifying properties mentioned above help to offset the risks unique to only investing domestically or internationally.
Globally diversifying a portfolio has never been easier or more accessible. Various mutual funds and exchange-traded funds (ETFs) among other products can help an investor achieve further diversification and possibly help reduce overall volatility. Any allocation toward foreign investments should fit within your overall investment strategy and financial plan. Your financial advisor would be happy to review the appropriate international allocation for your portfolio.