BUNK 43
FOREIGN STOCKS JUST FEEL SO . . . FOREIGN
Does even the phrase “foreign investing” give you shivers? Do foreign stocks just seem so . . . foreign? You’re not alone. Far too many US investors wholly ignore the non-US world. Or they may consider foreign an inherently “riskier” asset class, holding just 10 percent or 20 percent. Too little!
I’ve heard even established professionals claim foreign is “riskier.” Riskier than what, they don’t say. This is easily disproved with free public data and a bit of history. Truth is: Non-US equity and bond investing shouldn’t be any more or less risky than US investing. A good, well-diversified equity portfolio will benefit from being fully half in non-US stocks.
Fifty percent foreign? Seem outrageous? It’s not. The US is still the largest single nation in terms of total market capitalization—but it’s just about 49 percent of the developed world equity markets. 1 Considering the whole world—undeveloped markets too—it’s about 43 percent.2 If you’re US only, you miss more than half a world of opportunity plus extra diversification benefits.
Once upon a time, maybe it made some sense for US individual investors to ignore the non-US world. Sometimes, transaction costs for foreign stocks on foreign exchanges were excessive—eating into potential benefit. And we couldn’t always count on complete transparency from non-US firms. But in recent decades, as exchanges went electronic, trading globally is now quick and easy—you can buy lots of Chilean stocks as easily as any US stocks. Plus, US investors needn’t exchange money anymore—reducing that risk. American depositary receipts (ADRs) let US investors buy stock in many foreign firms on US exchanges in US dollars. And in developed nations and even in many emerging markets (if not most), accounting standards are normalized for publicly traded firms. Whether buying a French or Brazilian ADR or a US stock—accounting and reporting obligations are largely the same.

US and Non-US Stocks—More Correlated Than You Think

If non-US stocks were materially riskier, returns would be wildly variable. But they’re not! US and non-US stocks are more correlated than folks think—been that way for millennia. (In my recently updated 1987 book, The Wall Street Waltz, I have scads of charts showing strong correlations between the US and foreign markets going back centuries.) We live in a global economy—always have (at least much more so than people have commonly appreciated, as documented in that book)—and many of the same macro-economic forces acting on US stocks at any one time also impact non-US stocks.
Figure 43.1 shows US and non-US annual stock performance—as measured by the S&P 500 and MSCI’s Europe, Australasia, Far East (MSCI EAFE) indexes. Generally, when one is up, the other is too; US might be up or down more than foreign, or vice versa—but they tend not to go in opposite directions. If US stocks want to be down a lot, foreign stocks are down too. It’s a question of degree. There can be big divergences, but they’re short-lived. Since 1970 (as far back as we currently have exceptionally good data on non-US stocks—the work in my 1987 book was based on much more primitive and less precisely constructed indexes and data), US stocks have annualized 10.0 percent, EAFE 9.4 percent (measured in US dollars).3 There’s just no reason to believe, going forward, one or the other will be inherently better or inherently riskier over long periods. But the two together are overall more stable with less volatility than either by itself. Hence the diversification is worthwhile.
With this great diversification you are fundamentally reducing risk by fully investing globally. Think this through another way. Many complain endlessly that the US is doing wrong things socially and politically, and that will cause America to no longer have the global leadership position it so long held. Well, maybe that’s true; maybe it isn’t. But if you have those fears, that is even more reason to globally diversify.
Figure 43.1 S&P 500 and MSCI EAFE Annual Returns—Long Correlated
Source: Thomson Reuters, MSCI Inc.,4 S&P 500 price return, MSCI EAFE price return from 12/31/1970 to 12/31/2009.
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In fact, by not investing as broadly as you can, you could be missing opportunities to manage risk! But thinking you can’t benefit from foreign stocks is bunk addressed elsewhere (Bunk 44). There’s enough difference year-to-year between US and non-US stocks to reap benefits from diversification. So stop being a stranger to foreign and go fully global.
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