I’ll be running an occasional series of financial Q&As. These are curated questions I’ve answered in other financial forums. I may edit for clarity and change details to preserve privacy. Remember, I am not a financial professional so this is for your entertainment only. If you’d like to as a question, please reach out to me through this blog.
Q: I am learning about investing and recently completed your Building Financial Wealth and Freedom: Investing module. When thinking about asset allocation, how would you recommend splitting the percentage of investments between domestic and international markets? For example, in my mind there are first world countries whose economies are stronger than my country’s economy, so in my mind it would seem like it’s best to invest in stocks overseas. Is that a good strategy or should I have some domestic investments?
That is a great question and demonstrates your level of sophistication with investing. Generally research I’ve read covering this topic tends to have a US bias, so the question is usually framed in terms of “should I invest in only US stocks or diversify globally?” To this question I’ll give you two answers.
First, many smart people will advise that you can invest in just US stocks and be done with it. (I’m thinking of people like JL Collins, author of The Simple Path To Wealth.) Historically the US stock market has done very well, though with the rollercoaster ride you learned about in the investing module. The argument goes that most big US companies do substantial business overseas and so that gives you the international diversification that people seek by investing elsewhere. This isn’t the strategy I choose personally, but I think it is very reasonable and has plenty of smart people who support it.
The second answer I’ll give is that diversification is the closest thing to a free lunch you will get in investing, so the more diversified you can be, generally, the lower your risk. I like to spread my stocks and bonds across the entire globe. The US stock market represents somewhere between 55-60% of the total global stock markets all put together as measured by cap weight, so my investment plan puts 60% of my stocks in a total US stock market index fund (VTSAX) and 40% in a Total International (also called ex-US, meaning the entire globe minus the US) Stock Market Index fund (VTIAX). Looking back historically the US stock market has outperformed the rest of the world, so portfolios with just US stocks have higher returns. That doesn’t mean that will be the case going forward. Who knows, maybe the US will lag in the future and the rest of the world will outperform! I don’t know so I place my bets on everything.
The caveat I need to mention is that if you are from a smaller country, having what is called a “home country bias” (ex. I live in England so I put 50% of my stocks in the English stock market) underperforms historically. It is also riskier. If your country was on the losing end of a major world war, past stock market returns were really lousy, unsurprisingly. If your country’s stock market only represents 5% of the global stock markets, it would be less diversified and more risky to put a bunch of money in that one country.
Tl;dr: That is a lot of blah blah blah to say this: the more diversified you can be, the lower your risk, and the better you will likely be in the future. If you can invest globally in a low-cost, passive index fund, then that is probably the best choice.
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