Many investors, both in the US and across the globe, often exhibit an interesting idiosyncrasy called “home country bias”. That is an investor is predisposed to investing the vast majority of their assets in whatever country they call home. Simply put, most people just skip international stocks. And it’s hard to blame those folks given the recent events in Ukraine.
Both Jack Bogle and Warren Buffett are on the record advising investors to skip international stocks and rely only on the S&P 500 (or a similar US-focused index). Buffett claimed that a portfolio consisting of 90% S&P 500 and 10% US Treasurys was adequate for most investors, including the trustee of his estate.
However, this advice contradicts much of what Modern Portfolio Theory (MPT) leads us to believe about the benefits of diversification. Developed in the 1950’s by Harry Markowitz, MPT claimed that diversification can improve your tradeoff between risk and return. That is, you can earn a higher level of return for the same level of risk, or vice versa. MPT also argues for broad diversification. And the general rule is… the more the better.
What to believe
So who should we trust? Investing titans such with Bogle and Buffett or the ivory tower academics? Unfortunately, the answer is not so clear cut. Certainly, recent history has proved Bogle and Buffet right. Over the last 10 years (ending Feb. 28, 2022), US stocks have returned 14.21% per year, and international stocks just (*checks notes*) 5.75%. Gulp. That’s a difference of 8.46%… every year… for 10 years. Ignoring taxes, one dollar invested in the Vanguard Total Stock Market ETF (VTI) ten years ago would be worth $3.78 today. If you invested that same dollar into the Vanguard Total International Stock Market ETF (VXUS), it’s only worth $1.75 today. That’s a huge difference!
Bogle and Buffett also argue that investing in US stocks offers implicit exposure to international markets because many US companies are global in nature and receive a large portion of their revenue from non-US countries. And that’s a fair point. If you invest in a US company, and 50% of that company’s sales come from foreign markets, then your underlying economic exposure has some pretty solid geographic dispersion.
The other side
There’s no denying that US investors have had a great run over the past 10 years. Unfortunately, as investors we must look forward. So it’s reasonable to ask… can US stocks maintain their recent outstanding performance going forward? At this point, there are solid arguments in favor of international stock markets catching up on the US. International markets offer more attractive valuations based on a variety of metrics and many international markets have favorable demographic trends that could spur stronger economic growth and market returns.
And it’s fairly common for US stocks to outperform international stocks (and vice versa) for periods up to 10+ years. However, these differences tend to average out when you start looking at 20 or 30 year periods.
Another way to look at it… do you only invest in companies from your home state or city? I live in Virginia, and there’s no way I would limit myself to investing only in Virginia companies. Although there are some great companies in Virginia, excluding all the other states would exclude a huge pool of potential investment opportunities.
There is no “right” answer
There’s no way to predict how things will work out in the future. US stocks could keep on trucking while international stocks remain stuck in neutral. On the other hand, prudent investing often comes down to gaining exposure to a wide range of assets, including those that have underperformed for long periods of time. It’s also wise to keep in mind the old saying: “What got you here, won’t get you there.”
If you have avoided international stocks in the past, consider looking at your portfolio and thinking about whether increasing your allocation makes sense. If international investments don’t make sense for you, then feel free to skip them.
