Most advice regarding investment diversification is hopelessly outdated and hugely flawed.
Diversification at one point consisted of owning a bunch of stocks and bonds. Then it evolved into owning stocks of different styles (value or growth), in different sectors and across all market capitalizations. For bond holdings, owning bonds with different credit characteristics and durations gave investors more sophisticated diversification.
But diversification advice and analysis had (and still has) a glaring problem: it ignores the big picture. How? Consider the investable assets in the world. The sum total of all investable assets in the entire world consists of 22% U.S. equities, 24% international equities, 21% U.S bonds, and 33% international bonds (Source: Vanguard).
Your typical investment advisor applies diversification analysis only to your U.S. holdings, and then throws in a 15-30% allocation to international stock funds. And international bonds, the largest asset class in the world, are typically ignored.
There are reasons for this. One is just that living in the U.S. causes people to forget we are a part of a big world, so our home country bias is huge. The other is that international markets have traditionally been expensive and difficult to access.
But world markets keep evolving. International markets have become more liquid, more sophisticated, and the costs and complexity to access them has come down dramatically. But the largest asset class in the world (international bonds) has remained stubbornly difficult for U.S. index investors. That has all changed with the recent launch of the Vanguard Total International Bond Market ETF (NASDAQ:BNDX).
For years the common wisdom was that you needed to actively manage a portfolio of international bonds, and that the market just didn't lend itself to indexing. Obviously Vanguard didn't listen. BNDX give an index investor a completely diversified international bond portfolio with a .20% expense ratio, significantly cheaper than the 1.10% average expense ratio of similar funds (Source: Vanguard). It really is a revolution in international bond investing.
Given this new ability to access international bond markets cheaply and effectively, investors need to take a serious look at their portfolios and ask themselves if they are really, truly diversified. For myself and my clients, diversification means that the equity holdings consist of a 50/50 split between U.S. and international ETFs (or my favorite, the Vanguard Total World Stock Market ETF (NYSEARCA:VT)), along with a 50/50 split between U.S and international bonds. I want each segment of my portfolio to look like the universe of investable assets.
Legacy issues relating to international investing are still numerous. Vanguard calls its U.S. bond ETF the Total Bond Market ETF (NYSEARCA:BND). This makes no sense. It should be the U.S. Total Bond Market ETF. You might say I'm nitpicking, but Vanguard is being lazy with their product labeling and in doing so is passively perpetuating a U.S.-centric approach to investing. And most portfolio analysis programs still place your international funds and ETFs on the side as "international holdings" and do not let you blend those holdings into your entire portfolio so you can see your exposure to value and growth, market capitalization, credit, duration, etc. on your worldwide portfolio. This needs to change.
But you can invest globally now, with the utmost convenience and at a very low cost. So do it. Conventional wisdom will catch up with you someday.
Disclosure: I am long BNDX, VT, BND. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Baldwin Partners Group, LLC is a state registered investment advisor. Alex Bentley is the CEO, Founder and an investment advisor representative of Baldwin Partners Group, LLC.