In the US we often think of ourselves as the center of the universe and invest primarily in our own country. Many US investors put 15%-20% of their portfolios into international stocks for diversification. That still leaves 80%-85% bet on the US stock market and on the US dollar which is a big bet. Due to more rapid growth in other parts of the world over the past 20 years, the US now represents only 43% of the total global equity market values. Thus, to be truly invested on a globally neutral basis, a US investor would have to put 57% of their portfolio into investments outside the US. Is that a crazy idea or a smart idea? Is that too risky?
Will the USA be a laggard in the global economy going forward?
There is a good chance the USA could be a laggard in the global economy over the next 10 years. I am concerned about our ballooning deficits, increased government control and socialism, massive government spending, Social Security/Medicare shortfalls, and the rising tax rates that will be coming. Our corporate tax rates in the US are already the second highest in the developed world. Significantly higher tax rates in the future are inevitable to pay for all this spending and that will dampen economic and profit growth in the US. The government is now talking about healthcare reform in the US that will increase our deficits by another trillion dollars (CBO estimate) over the next 10 years. All of this excessive borrowing, spending and money supply growth has the potential to further reduce the value of the US dollar and to lead to future inflation. That is not good for US investors going forward. Our government, financial institutions, and consumers all have too much debt. They will be deleveraging over the next 5+ years to fix that problem. This deleveraging process will reduce future economic growth. It appears that the US dollar has the possibility of being replaced as the "global reserve currency" as many other international governments (such as China) and investors are worried about these same structural issues in the US. The US dollar recently (September 2009) sank to the lowest level for the year relative to other currencies. Has the USA passed its peak as the dominant and most successful economy in the world, much like the United Kingdom did 110+ years ago? US dollar weakness, relatively sluggish US economic and profit growth, and possible rising inflation in the US are several reasons to consider being diversified internationally. By investing internationally you are protecting yourself from a falling dollar.
Where will the best economic/profit growth be?
Stock market values are driven by real corporate profit growth over the long term. US economic and corporate profit growth is likely to lag behind many other parts of the world, who do not have many of the structural problems mentioned above. Do you think the US or the rest of the world will provide greater economic and profit growth over the next 10 years? Remember that the rest of the world includes the emerging markets such as China, India, Brazil, etc. that have been growing dramatically faster than the USA. Many of these countries have faster (and younger) population growth, are earlier in their development, have less regulation, and do not have many of the legacy deficits and rising tax rates that the US has. Investing in emerging markets internationally is riskier (political, economic, regulatory, currency) than investing in developed international markets or US markets. International emerging markets (led by China) now represent 12% of the global equity market capitalization. I think there is a good chance the global economy and a global portfolio are likely to beat a US based investment portfolio over the next 10 years. Capital flows freely around the world now towards the countries that investors believe will provide the highest after tax returns. The US will continue to grow, but on a relative basis other countries have a good chance of growing faster. On the positive side the US still leads the world in many important areas including college education, innovation, biotech and technology. It has not paid to bet against the US in a very long time.
Is a Global Investment Portfolio Riskier Than a US Based Portfolio?
No. Regarding domestic investing vs. international, Kevin O'Connor (President of Trusted Financial Partners) says, "Don't confuse the familiar (US stocks) with the safe." Based on our own research (studying data over the past 30 years), adding more international equities actually reduces the risk of a portfolio up to a 40% international weighting. The riskiness (measured by standard deviation of returns) of a portfolio with 60% international (a global portfolio) is equal in risk to a portfolio with only a 20% international weighting (a typical US biased portfolio). There are portfolio diversification (risk reduction) benefits to adding international stocks to your portfolio since domestic and international returns are not perfectly correlated. Correlations between US and international stocks have risen over time. Vanguard studied the risk of global portfolios relative to US portfolios and concluded that there were significant risk reduction benefits to adding international stocks to a portfolio up to a 40% weight. They also showed that a 20% international allocation was no riskier than a 60% allocaion.
Is a Global Investment Portfolio a Good Fit for You?
I think the globally neutral portfolio (with 57% international) is not riskier than a US biased portfolio and has a good chance of providing higher returns than a US portfolio over the next 10 years. The global portfolio is not a good fit for everyone, but everyone can consider increasing their international allocations to the level with which they feel comfortable. The global (or internationally heavy) portfolio may be a good fit for you if 1) you think globally, 2) you believe corporate profit growth and investment returns are likely to be higher globally rather than in the US over the next 10 years, 3) you are concerned about a falling dollar, and 4) you don't care if your quarterly/annual portfolio returns don't match up with US market.
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