I’ve devoted a lot of time recently to thinking about asset allocation. Thus, I was quite interested when the latest issue of “In the Vanguard” arrived and I saw that they had an article called “International Stocks: What’s a Reasonable Amount?”
In it, they argue that investors always seem to chase the flavor of the month and that, lately, that has meant loading up on international stocks. In fact, 85% of the net purchases of mutual funds in the first three quarters of 2007 were global or international funds. But given that today’s leaders are often tomorrow’s laggards, is that a good idea?
According to Vanguard analyst Christopher Philips, 20% of your stock holdings is a reasonable floor for international exposure, with a ceiling of 50%. Currently, non-US stocks account for ca. 50% of the world’s stock market value. Philips argues that having 20% of your stock position in international holdings captures much of the benefit available from international stocks, at least in terms of reduced volatility.
The closer you move toward 50%, the less additional reduction in volatility you will see. Moreover, other risks become more significant as you increase your international exposure, including currency risk, increasing correlations, and higher costs.
Thus, Philips argues that you should limit international holdings to 20-40% of the stock portion of your portfolio with the majority going to well-developed regions such as Europe and the Pacific.
As I detailed the other day, our investment allocation is smack dab in the middle of his range with 30% of our stock holdings being international equities. This works out to 24% of our portfolio as a whole.
I have a 529 plan with the state of Utah. The option which allows for the most international stock exposure (the 100% stock selection) is 10%.
Too bad, esp. since the article states that the floor should be 20%.
I think it’s important to remember that any conversation discussing the “correct” international allocation necessarily focuses on the past. In reality, that tells us nothing about what the ideal allocation will be going forward. A 25% international allocation is as likely to produce optimal results as a 50% international allocation. This may not sound very scientific, but just pick one. 30% is fine. 40% is fine. Whatever you pick will work so long as you stick to it over the long haul. The chances of you actually being able to identify the optimal international allocation ahead of time is practically zero so I don’t see much utility in fretting over it.
On the topic of home bias, I think there’s a very good argument for it. Most people are going to live and retire in their home country and spend their home currency, so it makes perfect sense to keep the majority of their assets in that currency. There’s nothing wrong with investing 80% of your portfolio in US stocks provided you intend to retire here. Now if you intend to retire in Argentina or Australia, you may decide on a different tact.
I say it depends on your age, your risk tolerance and what other investments you have. We are more aggressive in our 401ks and as such we each have about 50% in international investments and about 10% of our international holdings is invested in emerging countries (China, India, Eastern Europe, etc.) which is highly volatile.
Sam
I personally think that 32.385% is the optimal allocation for intl positions. ok, i jest. i’m at around 40% myself, although I struggled with increasing it from 10-20%. the reason being, yes, you can make good money in emerging markets, but the tides change very fast in emerging markets and it is a lot of risk. in stabler countries like the eurozone, i still had difficulty increasing my exposure, simply because the fundamentals of individual countries aren’t very strong. you still have high unemployment, a great deal of protectionism, and each country still cannot live within the % range mandated by the ECB. everyone talks about china and india being the next big thing. the jury is out as it is way to early. the dragons puffed out in the 80s after oh so much elevated sentiment. china has some serious socio-economic issues and the need for drastic increases in raw materials coupled with the fact that they have a huge population that isn’t benefiting from the boom, just makes it seem that china is already over extended. india, although they are booming in tech service area, they too have a huge swatch of disproportionate income society, and isn’t necessarily a stable govt or govt system. eastern europe just can’t get over its mafia based economic society. latin america can’t hide from itself and probably will, and has, reverted to its 80s butcher shops. the middle east, don’t get me started. considering many large u.s. companies already have significant intl exposure, do i really need separate intl exposure from what i already have by way of u.s. companies which revenues come back to the u.s.? this is also a good point to point out that you shouldn’t forget to include your u.s. stocks and funds that are comprised of global u.s. companies with intl exposure and to include that as part of your intl exposure. so for me, it was a hard struggle to increase my intl exposure.
I can remember not too long ago when it was aggressive to have 10% in international, then 20% and now 30% is considered the norm for most folks. Could this have something to do with the success of overseas markets? Of course. But you look at the decline of manufacturing in the US and the increase in finance (pushing money around creating bubbles) it makes sense to see more of your portfolio going overseas. Frankly I’m scared to invest in US companies that don’t manufacture something – guess that’s just me being conservative. But companies like DD and MMM have been very good too me – and they have a healthy amount of overseas sales.
Perhaps this is too big a question, but that are the best international vehicles along the range of higher/lower risk?
The last statement is true in itself but I ask myself these two questions:
1. can we really buy the market?
2. In theory buying the market reduces specific risks down to zero but does thery and practice meet?
By limiting the “efficient frontier” of portfolios you are making choices. I agree that the choice should be more thought out than just buying another 5% share in emerging market indices.
I say 50% because I want an accurate market-weighted index of the entire global equity market. You are right that international funds have currency risk and slightly higher expenses. However I think all the arguments in favor of using an index to pick which companies to buy also apply to picking which nation to invest in. Any time you overweight something you\’re implicitly saying you know more than the market.
I agree with the numbers stated in your post. It’s funny but there’s a home bias towards your domestic market, even if you live in small countries with highly volatile stock markets. Chinese, for example, can’t invest elsewhere.
I think an international asset allocation is a very interesting way to increase potential return and risk. For example, investing 10% of your portfolio in emerging markets generated very nice returns over the past few years. It is very risky though, and should obviously be done in order to capitalize on their long term growth.
While there is no percentage that is right for everyone, there has been a shift in the past 5-10 years that suggests you should have more international exposure. It wasn’t too long ago when the typical recommendation was only 10%, and people thought that investing overseas was just too risky.
Clearly, there are many economies across the globe that can provide some decent diversification and work to to minimize volatility that having all domestic stocks can carry.
That being said, my portfolio contains around 27% of all equity holdings in international.
I think 30% is right on. If you look at most of the asset allocation books, they advise to have around 30% +/- 5%. I currently have 30% in my Roth and 401k