Does international diversification make sense for investors? Will investing globally indeed hurt financial performance?
Winning comes and goes
Over the past 10 years, the US stock market has grown more than twice as quickly as the rest of the world’s. But this localized financial strength is far from a given. Over the latest century, the US has been in the “losers” column for five out of 10 decades: the 1930’s, 1950’s, 1970’s, 1980’s, and 2000’s. During these periods, international stocks grew more quickly than America’s. How much money one should ideally put into foreign investments is debatable. But based on history and logic, the US’s current winning streak won’t last forever. While people tend to assume that recent circumstances will persist, adopting a global view on investing provides the best chances of strong performance and less risk.
It’s a big world
Picture someone who only invests in companies in New York. While being an economic engine, NY hosts only 11% of America’s top companies, so sticking just to that state means missing many opportunities. The same could be said about having a financial bias for one country, no matter how dynamic. Is General Motors a better investment than Toyota (Japan)? Is Exxon better at oil production than British Petroleum (UK)? Is Wells Fargo a more profitable bank than Santander (Spain)? Are Apple and Amazon more innovative than Samsung (South Korea) or Alibaba (China)? The US is home to many top global firms, but simply ignoring great companies elsewhere means missed investment potential.
The action is in emerging markets
The US’s dynamism may be fading. In the 1970’s and 1980’s, people thought Europe and Japan were the growth engines of the world. In recent decades, however, shrinking populations and ineffective politicians have led to a sharp decline in those regions. Although America is still growing more quickly than those aging economies, the real growth in the world today is in third-world countries. The world’s future population growth is projected to be in developing countries, and their economies are expanding much more quickly than America’s. Because of this expansion, emerging markets’ stocks (mainly China, India, Brazil, and similar countries) have earned significantly higher returns than the USA over the past 20 years (but not the past 10). It may be a big mistake to ignore this significant financial trend.
Buy low and sell high
Based on the simple investment premise “Buy low, sell high,” investors should be very excited to invest internationally at this point. Years of under-performance relative to the US means that there may be more room for future growth globally than locally. You may have noted in the list of decades earlier that there seems to be an ebb and flow in which area has higher returns. This may reflect the investment and valuation cycle: as the US did better, its room for more growth was limited, giving other countries a chance to pull ahead for a while. By investing narrowly, an investor is more likely to ride boom years higher but also the bust years lower.
Diversification vs. Diworsification
This tendency of markets to fluctuate is the bottom line. Unless someone is a professional trader, they need to diversify to ensure they don’t spend years on a dead-end strategy. Some call diversification “diworsification” because spreading eggs into multiple baskets makes it less likely that one win will turn into a monster gain. This fact is true. But a balanced strategy also minimizes the chance of a terrible loss. It is sensible for people to take limited risks once they get beyond their fields of expertise. Did you do the research and come up with substantial rationales to explain why the USA will always be the best place to invest? Historically, long-term investing internationally lowered a portfolio’s risk without holding back growth. Recommendations for international exposure range from about 20% to 40% of (stock, not bond) investments, but most experts feel it is the wise way to go.