This Table Suggests U.S. Investors Would Be Well-Served By International Stock Funds

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Includes: AGG, EFA, EWC, IJH, IJR, IVV, QQQ, VNQ
by: Dale Roberts
Summary

Most investors suffer from a home bias. We invest more, or too much, in our home country.

That home bias increases our geographic concentration risks.

US investors might be suffering from a recency bias as well. Recently the US has outperformed International, but that has not always been the case.

US investors might be able to create considerably greater risk adjusted returns with a 20-30% allocation to international developed market and developing markets funds.

I have been examining my ETF model portfolios. The core portfolios are mostly plain-vanilla with the standard building blocks. Based on conversations with many portfolio modellers, I wanted to take another look at the core portfolios to see what might be added to complete the packages. The goal, of course, is to create portfolios that might deliver even better risk-adjusted returns.

So what would we add to the core portfolios?

As I have often suggested, investors might include a REIT (VNQ) component. From my observation of the model portfolios constructed by many of the Robo Advisors, and from my conversations with these portfolio-builders, I am certainly on board with that REIT top-up.

Real estate is only some 3-4% of the Canadian (EWC) and US large-cap or broad-based indices. Some will argue that not only is real estate a desirable sector that should be given the percentage of portfolio allocation it deserves, many will argue real estate is its own distinct asset class.

Seeking Alpha readers will know that the site's most-read REIT analyst, Brad Thomas, would likely give that argument a go.

Whether or not we want to call real estate a distinct asset class, it might be a sensible move to top up your ETF portfolio or stock portfolio to a level of comfort. That might be an additional 5%, 10% or more, depending on your take on REITs as an asset class or simply as a very important sector.

OK, but what about international diversification?

That REIT investigation took me to many sites and studies. I started to graze and wander around the net. It led to a discovery - a great table on the optimal allocation for a US investor, on US vs. international stock holdings.

For a US investor, core building blocks might include a broad-based US market fund (IVV), international developed market fund (EFA) and a broad-based bond index fund, such as [[AGG]]. And, of course, those REITs. There are certainly other ways to spice things up.

So how about that split between US and international?

Have a look at this table, courtesy of Merriman Financial. (You can also download the PDF):

What's more than striking is that the all-stock 60/40 US/international portfolio outperforms the all-stock S&P 500 portfolio at 10.7% annually vs 10.5% annually. The maximum draw-down for the US/international portfolio was 37.3%, vs, 50.9% for the US-only portfolio.

Better risk-adjusted returns over the longer term with international holdings

We might all be suffering from some of the recency bias. US stocks outperformed International through the last recession and major stock market correction. But go back to the previous major corrections and it becomes advantage International. I often write about the lost decade for US stocks. How quick we forget. While US stocks suffered, Canadian and international stocks did reasonably well in the 2000s. We had an extreme overvaluation event in the US major indices heading into 2000. We had that tech bubble, which burst and left a bloody mess. (Full disclosure: I was splattered with my personal US QQQ and science & technology fund holdings. Ouch! )

Look to the above table snippet and you'll see the US market (S&P 500 Index) falling by those larger figures in 2000, 2001 and 2002. The 100% stock column represents a 50-50 mix of US and international.

Go to 1977 and look through the '80s as well, and you'll see some more support for international stocks. In 1977, when US stocks were down by more than 7%, the US/international mix was up by some 28%.

The table also gives us a nice look at asset allocation models from 100% bonds up to those all-stock models.

Yeah, but US stocks in 2019 are not the US stocks of the hippie decades

True. These days many of the US large-cap companies are true multinationals. Many companies will generate some 40%, 50%, 60% or more of their revenues overseas. Apple (OTC:APPL), for example, is estimated to hold some $250 billion in profits in overseas accounts.

Back in the '70s, US companies were certainly not as international. Given that, when we buy a US multinational today, we are already benefiting from extensive international exposure, so an investor might factor that into their asset allocation decision. That said, investing in the international index funds is the bedroute to investing in entirely different companies (obviously), and additional diversification will be readily obtained.

Given all that, it's certainly a personal consideration and decision. As a starting point, US investors might be well served by adding 10% international and 10% specifically Canadian. The Canadian market being more resource- and materials-based can offer up a unique type of diversification.

Many of the modelling suggestions from Vanguard and BlackRock (BLK) will suggest a 20 to 30% allocation to international funds as a starting point.

What say you? What is your allocation to international stocks or funds? If you have a true US home bias, why?

Canadians can also chime in with their home bias stories, eh?

Author's note: Thanks for reading. Please always know and invest within your risk tolerance level. Always know all tax implications and consequences. If you liked this article, please hit that "like" button. Hit "follow" to receive notices of future articles.

Disclosure: I am/we are long BNS, TD, RY, AAPL, BCE, TU, ENB, TRP, CVS, WBA, MSFT, MMM, CL, JNJ, QCOM, MDT, BRK.B, ABT, PEP, BLK, NKE, WMT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.