According to the Wall Street Journal, it is important for American investors to avoid “home-country bias.” If foreign markets are ignored, returns could be crimped and volatility increased. Read this compelling article below.

Your Money Needs to Go on a Vacation

By ignoring foreign markets, American savers could crimp future returns and face more volatility

By Spencer Jakab, November 10, 2023

A record number of Americans have been planning a foreign vacation. They should take their stock portfolios along with them.

Keeping too much of your money where you live is a classic financial error called home-country bias—but it has been a lucky mistake lately. Not diversifying has paid off.

Doing the wrong thing and getting the right result is no reason to keep doing it, though. In fact, it makes this an especially good time to diversify and look at the other three-quarters of the world’s economy. Foreign stocks look like a bargain.

“If you’ve been 100% the U.S. the last 15 years, drink some Champagne, pat yourself on the back, but it’s probably the wrong choice now,” says Meb Faber, chief executive of Cambria Investment Management, an independent advisory firm.

He points out that in 2009 valuations of foreign and domestic stocks were very similar and that most years in history guessing which would do better was “basically a coin flip.” Yet during the 15 years through this October, owning a basket of U.S. stocks tracked by index provider MSCI left buyers with nearly six times their money before taxes. If they had followed standard financial advice and put some of it into stocks from the rest of the developed world like those in Germany, Japan, Britain or Australia, they would have earned a pedestrian total return of 155% on that part of their portfolio. Emerging markets, long touted for their rapid economic growth, would have been even worse, returning a measly 143%.

Since 1970, though, there have been six stretches when foreign developed market stocks trounced their U.S. counterparts. In the most extreme example, during a six-year span in the 1980s, foreign stocks beat American ones by 374 percentage points, according to JP Morgan.

It has never been easier to diversify, including through low-cost exchange traded index funds. The downsides are minor: Foreign dividends might not be treated as generously in a taxable account. Investors also assume some foreign currency risk. But U.S. multinationals that dominate the S&P 500 like Apple and Tesla have that problem too.  Meanwhile, foreign giants like Switzerland’s Nestlé or Japan’s Toyota have massive U.S. sales.  And commodity producers like Anglo-Dutch oil giant Shell or Australian miner BHP Group sell their products in dollars anyway.

“These borders are increasingly meaningless,” says Faber.

Americans are lucky. Just as U.S. tourists can get by only speaking English abroad, the domestic market is so enormous at about 60% of global value that financial homebodies hurt themselves less than those from any other country. Consider the sad fate of a Japanese investor who embraced the country’s go-go market in the late 1980s. A measure of valuation called the cyclically-adjusted price-to-earnings ratio was 4.4 times as high as for U.S. stocks in March 1989, according to Barclays Indices. Japan’s bubble burst the following year and now it looks like a bargain—40% cheaper than U.S. stocks. The benchmark Nikkei 225 Index is only around four-fifths of its peak 34 years later.

Japan isn’t the only place investors’ money goes farther. U.S. stocks fetched 17.8 times expected earnings for the next 12 months on Nov. 1, according to Yardeni Research. The U.K. and Germany each trade at just 10 times. Spain and Italy are even cheaper at 9.4 and 7.5 times, respectively. Emerging markets offer a veritable bargain bin for the brave with Israel at 8.3 times, Brazil at 7.3 times, Pakistan at 5.3 times and Turkey at 5 times.

A natural reason to balk at sending your money to foreign shores is that, well, they are foreign—you probably know much less about them. Even Americans who can afford the luxury wares of France’s largest listed company, LVMH Moet Hennessy Louis Vuitton, might have no clue about French tax policy or takeover rules.

Resist the temptation, though, to pick an active manager flashing brochures of its intrepid portfolio managers touring exotic locales and figuring it all out for you. They are even less likely than active U.S. fund managers to be worth the expense. In 2022, 68% of international stock funds and 76% of emerging market stock funds failed to even beat their index, according to S&P Dow Jones Indices.

It is every investor’s nightmare to pick up the newspaper and read about a company she owns running into financial difficulties. There might be a cheaper way to blunt the risk, though: Invest in quality stocks. BlackRock calculates that a basket of international stocks with high return on equity and low earnings variability and debt-to-equity beat their lower-quality counterparts a whopping 98.8% of the time over five-year rolling periods between July 1990 and April 2023. There are several index ETFs that focus on domestic or international quality.

It has been a great decade plus for American investors who ignored standard advice and kept all of their portfolio at home. Better lucky than smart, as they say on Wall Street. Now it’s time to spread some of that windfall abroad.

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