Most Investors Think Locally, Don’t Invest Globally
*Articles and content provided by SigFig Wealth Management, LLC.1
Everybody likes rooting for the home team and glaring at the fans wearing the visitor’s cap. And if you’re talking baseball, we’re with you. In investing, however, sticking with your home team—or home country—is a risky move.
The world of investing
Nations have different regulatory environments. Some specialize in particular sets of industries. Some are in the midst of massive economic growth, and others are in crisis. All of these factors affect the companies operating in those countries, and the stock exchanges those companies trade on.
In other words, you can think of international stock markets as being like companies: some go up, some go down. And like individual companies, countries (and their stock exchanges) can also go bust — or flourish. Stock markets can go to zero (usually due to war) or crash and stay low for decades — or they could outperform.
Owning a healthy mix, also known as diversification, can lower the risk of a portfolio.
This isn’t just an academic argument: Vanguard reported in a February 2014 white paper that international investing really did reduce a portfolio’s volatility. (Incidentally, they also considered the question of whether investing in multinational corporations headquartered in the US provided similar diversification. It didn’t.)
What’s in your portfolio?
The US accounts for a little over 35% of the global stock market, and advisors typically recommend American investors make at least 20% of their stock holdings international. Note that this is percentage of stock holdings — not an investor’s portfolio as a whole. Depending on risk appetite and investment horizon, that translates to, roughly speaking, between 15% and 65% of one’s overall portfolio.
Are regular investors heeding this conventional wisdom, though?
The median SigFig user has 3% of their portfolio in international stocks; 4% of their stock allocation.
The Equity Home Bias Puzzle
Why are so many investors skipping international diversification? It’s a phenomenon known as the equity home bias puzzle. To put it simply, people prefer to keep their investments close to home.
According to the Investment Company Institute, 27% of the money invested in equity mutual funds in the US is in international stock funds. That’s much closer to Vanguard’s recommendation, at least – but the figure is probably exaggerated by including institutional money like pension funds, hedge funds, and endowments.
Maybe our users are holding international stocks in a portion of their portfolio not synced with SigFig (such as a pension fund).
Maybe they just love rooting for the home team.
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