You will hear many times to invest in stocks, but what does that mean? Are you to buy a few individual stocks, the S&P 500, or stocks overseas? There are different views of what one’s equity allocation should be. In this post I will attempt to simplify and offer a low-cost solution of an equity investment.
Case for US Only
Two people who I admire greatly, Warren Buffet and John Bogle, suggest investing in the S&P 500. They believe it will offer satisfactory results as well as give some non-US exposure as a lot of companies do business overseas. While I respect their advice greatly, I can’t find any research that supports their suggestion. One would think that all your assets in one country is inherently risky.
Case for Non-US Diversification
Fidelity investments, in their “5 myths of international investing“ research says that US based companies doing business overseas do not offer the diversification needed. Companies are correlated with their home country and despite doing business abroad, will move with their home market. They also give performance metrics ranging from 1950 to 2016. Below you will see that the US has outperformed by quite a bit, but when you combine US and Non-US into a 70/30 portfolio rebalanced every year the performance converges. You can also see the diversification benefit by the standard deviation being the lowest of the three options.
|1950 to 2016||U.S. Portfolio||International Portfolio||Globally Balanced Portfolio 70% U.S./30% Int'l|
My initial take on seeing the above is what if I don’t care about the risk. If you are a long-term holder wouldn’t you want the highest return? The below chart is what finally pushed me towards having some non-US exposure. The white line represents non-US stocks and the green is the S&P 500 over a 49-year period being in 1970. Long term results agree with Fidelity’s findings of the S&P 500 outperforming non-US, but what if your investment began in 1970 and you took money out 20 years later? Most people would agree that 20 years is enough of a long-term holding period. If one took their money out in 1990 their investment in the S&P 500 would have drastically underperformed the non-US investment.
Now that I made the decision to invest in foreign stocks, how much should I hold? In Vanguard’s “Considerations for investing in non-U.S. equities” research article they suggest a 20% to 40% allocation. Allocating 20% to non-US equities would offer 84% of the diversification benefit while 30% would provide 99%. I have chosen to utilize 20% as a middle ground between the research noted and Mr. Buffet and Mr. Bogle advice. The 20% allocation will offer most of the diversification while still not deviating much from their advice.
Index Fund Suggestions
Two choice for mutual funds that I would suggest are either Vanguards VTSAX (US) and VTIAX (Non-US). Fidelity also offers zero expense ratio options, FZROX (US) and FZILX (Non-US). Either of the choice will serve you well depending on which brokerage account you are using.