by Marcio Silveira, CFP, CFA, CAIA, Pavlov Financial Planning
Do you invest too much where you live?
If you are like most people, your answer is “yes”. The majority of investors act this way
because familiarity builds confidence. The problem is that this confidence does
not really mean knowledge and expertise. Investing too much where you live can
mean missed opportunities and taking too many risks. The technical term for
this behavior is the home-country bias.
For U.S. based investors this tendency is not a very serious
problem. This is simply because the United States has a large share of global
investable stocks and represents roughly 40% of the global stock market.
Being based here in the United States allows us to invest in
any part of the world in a very cost effective way, but we generally miss this
opportunity because our home-country bias is skewing our investment
decision-making. We typically have over 80% of our stock portfolios based in
the U.S. Burton Malkiel, a professor at
Princeton University, discussed the home-country bias in this interview.
This tendency is much more serious in smaller countries,
however. Investors based in Canada, for example, hold the majority of their
stocks in Canada, but their market is less than 5% of the global market. These
investors will also have a disproportionate exposure to some specific
industries that are prominent in each market. In the case of Canada, there will
to a very large exposure to commodities in general and mining in particular. It
is certainly too much risk that is easily avoidable.
Immigrants and Expats
The problem persists when investors move. Immigrants in the
United States keep investing too much in their countries of origin. There is a
false illusion that they know what is really going on. The reality is that most
immigrants know very little about the drivers of stock market performance in
their countries of origin, and they invest there simply because of familiarity
and the confidence associated with it.
U.S. Expats in other countries also tend to have too much of their investments in the United States, but they
also invest in their new countries of residence. The result of neglecting other
countries is an investment portfolio that can miss opportunities for better
returns in relation to the risk taken and, in some cases, reckless risk
Owning the World
The most sensible approach to benefit the most from
diversification (which reduces the risk while keeping the expected return) is
to have a globally diversified portfolio. This is accomplished very easily by a
U.S. based investor with very simple portfolios of less than 5 Exchange Traded
Funds – ETFs.
In the extreme, this global diversification can be accomplished with just one
security. An interesting example is the Vanguard Total World Stock ETF (ticker:
Having a true global exposure allows investors to keep the
course of consistent investment with controlled risk because of the very broad
and Opportunity for Non-U.S. Investments
In the past 3 years, U.S. Stocks have performed
significantly better than International Stocks (including Developed and
Emerging). This means that the relative stronger performance further increases
the weight of the US in the global stock market. For example, the Vanguard Total Stock Market ETF (U.S. Stocks) has returned
20.5% over the past 3 years and the Vanguard Total International Stock ETF
(International Stocks) has returned 8.94%.
The conclusion is that investing internationally in a
meaningful way is always sensible, and right now there seems to be a particularly
good opportunity to do so.