How did you celebrate Independence Day this year? Did you gather friends and family for a barbeque? Go to the lake? Light fireworks?
Every year Americans set apart time to celebrate on July 4 to recognize the freedom we enjoy in this great country, often considered the greatest in the world.
When it comes to stock investing, however, how great is the United States?
That question has been dissected and discussed for decades. The answer is incredibly important, as it has ramifications on how each and every one of us should invest our hard-saved dollars.
Some believe – several prominent investors among them – investing exclusively in the U.S. stock market offers the best chance for superior long-term returns. As support, they note large companies sell products and services all around the world, so those companies inherently offer exposure to foreign markets. Plus, America has a productive capitalist system and rule of law. Why, they ask, would you consider investing in companies who do not operate in such an accommodating environment?
Others are convinced good ideas and good companies can exist anywhere in the world. Why, they ask, would you want to limit your investment landscape to only one country? In their view, investors too often stuff their investment portfolios with U.S. stocks and mutual funds simply because it’s the country and companies they know and love. They have even given this prejudice a label. They call it a ‘home country bias.’ And falling victim to this bias could negatively affect your returns, they say.
So what should you do? How should you invest? Looking at the data can be instructive. The following chart shows the relative performance for U.S. and non-U.S. stocks over the past 30 years.
Looking at recent returns, it is clear why some investors point to investing exclusively in U.S. stocks. Investing only in the domestic stock market has certainly been a winning strategy lately. Since 2008, the U.S. stock market has averaged 7.3% per year versus -0.6% for non-U.S. markets. That’s a massive difference.
Widen your lens, however, and you see that the conditions were the exact opposite in the early 2000s. From 2002 through 2007 non-U.S. stocks were by far the better performer (16.0% versus 7.1%).
It is impossible to reliably predict when the tide will shift and when U.S. or non-U.S. stocks will outperform. Therefore, the best strategy is to diversify. It is not one or the other. You can invest in both.
So how much of your portfolio should be invested internationally? Generally, 25% to 40% of your stock allocation is a reasonable target to invest outside the U.S. stock market.
As much as we love this country, fireworks, and a good barbeque, when it comes to investing, we should not limit our investments to only U.S. companies. There is a whole world of opportunity out there.