How Much Should I Invest In International Stocks?
How much should we invest internationally? That’s the question that I want to explore with you today. Last week, I posted What’s Wrong with this 401k Asset Allocation? and SJean commented that “25% international is risky” — a sentiment that is shared by a few other commenters. I don’t agree with the comment and want to get your input regarding what percentage of our portfolio should be allocated to international equities.
Photo from NASA
A quick search landed me on The Digerati Life where she offers a chart that shows foreign exposure from 25% as “aggressive”, down to 0% a “very conservation”. In it, she also offers 5 points on the risk and cost involved.
As I continued my search, I also found this cool The U.S. Economic Map Vs. The World at The Global Guru. I don’t have the permission to show the map here, but you should give the article a read. This article gave me an idea to think differently:
What if we think of each country as a company stock?
According to the CIA, the U.S. economy was estimated to be $13 trillion in 2006 (purchasing power parity) and the gross world product (GWP) was $66 trillion. As such the U.S. as a company, represents nearly 17% of the total market capitalization. From this perspective, wouldn’t investing 75% in the U.S. equity market be considered risky when it only represent 17% of the gross world product?
Personally, 28% of my portfolio is invested internationally, and this is risky based on conventional wisdom. But from the perspective I provided, isn’t it a bigger risk to invest 72% of my portfolio solely in the U.S.?
This article was featured in the Carnival of Financial Planning hosted by The Skilled Investor.
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I definitely do not subscribe to the belief that having 25% of your portfolio in international is “aggressive” or “risky.”
I think it’s good, common sense to do so. It’s good diversification, if nothing else. I have 30% of my retirement in international, and I consider myself to have a relatively low risk tolerance.
Dave Ramsey, who is about as conservative as you can get with money, recommends having 25% of your retirement in international – and that’s if you want “conservative diversification.”
Ramsey is better at debt elimination than investing, but this seems to be standard (if not conservative) advice from what I have read from various other sources.
@Kev – thank you for pitching in! 25% seems to be the number people throwing around. I don’t remember the blog, but I have seen someone said as much as 45%, but I haven’t heard anyone talk about having more than that.
20% – 30% of your equities in international funds is the so-called “sweet spot” when you maximize returns while controlling risk. You’re doing well with that 28% international allocation! I’ll be following up on this matter at some point as well as I’ve done more research on it….
@The Digerati Life – I look forward to it. Thank you for stopping by.
Well I’m nearly 75% invested internationally. Of course it’s a lot riskier and I’m being hammered recently by the world wide downturn…but then so is everyone else. Tough market right now. That’s why it’s so important to have a long term perspective or it might cause one to trade on emotions alone.
-R
I’m about 75:25 domestic to international (and that’s a different domestic to you). In our 401(k) equivalent at work, the default fund is 50:50.
One of the reasons that you don’t want to match the world capitalisation figures, is I think to do with the increased risk due to currency speculation. It’s also usually cheaper to invest at home.
@Raymond – wow, 75%. What’s your justification for that much international?
@Plonkee – good input regarding currency risk and cheaper to invest domestically.
Ideally, I’ll eventually be invested with at least 25% worldwide.
Here’s another question for you—if so many American companies are multinational now, does that automatically make the S&P500 semi-international?
@Mrs. Micah – great question that I haven’t thought of. I did a search and found this on Advanced Personal Finance: For companies in the S%P 500, 37% of their total revenue is from non-domestic source.
I’m with Raymond. About 75% in other countries, mostly China and Latin America. My reasoning?? There’s still quite a bit of room for growth in the up-and-coming countries, and (recent) history shows great returns. Long-term it could be risky, but no risk, no reward. So far for me it’s been a minor skyrocket.
When I started investing, about 20% was the general number for international, but the world has really changed a lot since then. I would feel good about going higher, I have about 40% in mind for myself.
Good points about U.S. companies having such broad international exposure these days.
I really think the line between domestic and international is blurring quite a bit and will continue to do so. I would think more about the diversifying the businesses I’m invested in rather than where those businesses are located.
Of course, the other rule of thumb it to invest more aggressively when you are young, so I would definitely say go beyond 25% international for most of us.
I’m not sure about your capitalization numbers. I thought the US market was about 50% of the world’s capitalization.
Either way if you want more diversification you have to spread out a bit.
I have about 80% international but being a Canuck – things are a bit different. Our stock market is only about 3% of the world’s stock markets and our market is not all that diversified, especially compared to the US market.
Mike
@Raymond and Randall – Are you both U.S. based? I just want to clarify.
@FinanceAndFat – Welcome to Moolanomy. I like what you said about the evolution of the world economy. May be 40% is the new 25% and 20% is the new 0%?
@FourPillars – I couldn’t find the capitalization number. The number I presented was Gross Domestic Product numbers (from the CIA website). Are the two the same?
I appreciate the insight about the Canadian market. May I ask what percentage you’ve invested in the U.S. and why?
@Pinyo – I’m U.S. based. But since about 2001, I’ve thought about posing as an Aussie if I have to travel abroad. Safer and people treat you nicer.
(2008, Can’t Wait!).
Oops! How’d that slip in there.
M – no the GDP and capitalization are not the same. I think the GDP has to do with the value of goods and services produced by a country.
The capitalization is the stock market value of a company or group of companies. So the sum of all US companies capitalization as a percentage of the all the worlds companies capitalization gives you the percentage of US capitalization.
This post has a chart (might not be totally up to date) showing the various capitalizations.
http://www.efficientmarket.ca/.....Allocation
In my equity portfolio (which I’m still fiddling with) I’m planning to have about 35%-40% US equities (VTI to be exact). It’s a bit below the market capitalization number of 50% but that’s because my Canadian equity is higher than the 3% of world capitalization.
Hope this makes some (any?) sense
Mike
Yes, I’m from the Washington D.C. area.
Happy Thanksgiving!!
@FourPillars – Thank you for the information. I found another, more updated information about the U.S. Market Capitalization versus the World on WikiAnswer.
* U.S. market cap is approximately $15.35 trillion (May 23, 2007).
* Global market cap is approximately $51.23 trillion (January 2007).
According to this, the U.S. is about 30% of the world market capitalization. Slightly better, but the same questions remain: Are Americans narcissistic when it comes to investing in the U.S. versus abroad?
Pinyo – thanks for pointing out the updated info. It’s amazing what a currency swing will do – up until a year or two ago the US cap was about 50% of the world cap.
In my opinion – now is the time to buy American!
I would guess that Americans focus a lot of their investment on US equity but given the size and diversity in that market, I’m not sure that’s a bad thing. The main reason foreign (to you guys) investments have done so well is because of the currency so that’s another thing to think about when investing.
Mike
37% of their revenue eh? Well then I’d see my index fund as something related to international investing even if I didn’t classify it as such. I’d probably feel comfortably diverse with the 25%, knowing that another 37% came from abroad.
@Mike – no problem — 50% to 30%, I don’t know if I should feel good at this point. I think you’re right about this being a good time to by American.
@Mr. Micah – If you look at it that way 37% of 75% is 27.75%, so we are looking at around 52.75% international.
@Mrs. Micah – Now that I give it some thought that 37% doesn’t matter because international companies also have revenue in the U.S. which should nullify the international revenue.
Vanguard put together a great article on international investing. 20-40% was the end result. I’m at 20% now, but plan on bumping it each year for a couple years.
@Madison – Oh, please share the link!
Yeah, it’s a hard pill to swallow to bump up the international allocation right now — with the weak dollar and all. But I think it’s the right thing to do in the long term.
@Pinyo: Here it is! https://institutional.vanguard.com/iip/pdf/ICRIECR.pdf
I’m sitting with MoneyBlueBook and have close to 70% international as well – The dollar hasn’t been splendid lately, but it WILL come back, just not till after this “housing debacle” works its way out… Then I’ll consider coming back…
Right now, investing 25% internationally is probably a safer bet given the huge drop in US stock markets, although these are only temporary and I think they will recover within a few short years.