Yesterday, we wrote about the value of adding foreign stocks to a portfolio. The next question we wanted to answer was how much of your portfolio should be in foreign stocks. Unfortunately, there isn’t a right answer to the question. It is probably more art that science, but we do think there are some key points investors should be aware of.
- The US Market represents about 40% of the total market capitalization of the world. This is a good starting point to determine how much of your portfolio should be in US versus foreign stocks.
- Our own research shows that adding foreign stocks to an all US stock portfolio brings down the risk of the total portfolio, so we recommend that most clients have at least 30% of their equities in foreign stocks
If the US market makes up 40% of the total world stock market, why would we advocate having 60 or 70% of our client’s portfolio in US equities? There is good reason for this “home country bias” that investors should consider when designing their portfolio:
- Fees for US equity funds are less than foreign equity funds. According to Morningstar, the average expense of a US Large Blend Fund is 0.48%, Foreign Large Blend is 0.74% and Emerging Markets is 1.10%.
- Trading costs are lower. One study found that trading costs for US Equity funds averaged 0.36%, Foreign funds 0.45% and Emerging market funds were 0.61%.
- Behavioral– when investors significantly weight foreign stocks in a portfolio there can be more of a tendency to tweak the portfolio over time since there will be many years with significant underperformance to indices like the S&P 500. Since most of us tend to compare our portfolio to the market we see on TV or on the internet (like the Dow Jones or S&P 500), we must ask ourselves the question whether we would feel comfortable significantly trailing the US market during some years. I have found that the more a client deviates from their perceived “home market” the higher the possibility for tinkering with the portfolio.
For all these reasons, most clients would be well served by keeping a larger portion of their equities in US stocks.
Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.