Why Should I Care About Foreign Diversification for Stocks? Can’t I just Buy all Tesla? Or Google? Or Amazon?

Table of Contents

• Introduction
• What is Home Bias and Is It Wrong?
• How Much Should You Invest in Your Home Country?
• Do Any of Our Listeners Live in Those Countries?
• What Should Our Listeners Do?
• What are Market Caps, Developed, and Emerging Markets?
• Why the “If Any” in Emerging Markets?
• How Much Should Our Listeners Have in US vs. Foreign Stocks?
• US vs. Developed International Stocks
• Small Cap and Value Stocks
• Conclusion

Introduction

Madison: Hello, everyone, and welcome to the 11th episode of Not Just Numbers, Honest Conversations with a Financial Advisor and Lawyer. I’m Madison Demora, and I’m here with Mike Garry. Mike is a financial advisor and CFP and the founder and the CEO of Yardley Wealth Management. He is also an estate planning lawyer, and his law firm is Yardley Estate Planning, LLC. Hey, Mike.

Mike: Hey, Maddie.

Madison: So, Mike, what are we going to discuss this episode?

What is Home Bias and Is It Wrong?

Mike: Maddie, I got the idea for this episode from a local listener, Howard. Howard is a very bright guy and he thought we might want to discuss the question of whether people should invest outside the US or should we just stick to US stocks and stock funds? I think the answer to that question is we should definitely invest outside the US. The question for me though, is how much to invest in foreign companies versus US companies. And I think it’s always a good topic of discussion. There’s a lot of home bias in investing. Those are my words, not his. And it’s worth unpacking that just a little bit.

Madison: So what is home bias and is it wrong?

Mike: The home bias is the idea that most investors in most countries invest most of their own money in their own countries and not so much elsewhere. It’s a real thing and it happens all over the world. It’s not just US investors have home bias. UK investors, French investors, they all have home bias. And it’s not like a morally wrong or anything like that. But I think how good of an idea is depends on a lot of factors, some of which may be fairly complicated. But it does make intuitive sense. If we live here and work in the US that are planning to retire here, makes sense to invest here too, right? And US has had a good track record both recently and over the long term.

How Much Should You Invest in Your Home Country?

Madison: Okay, but how much should you invest in your home country?

Mike: Well, that’s a tricky question. Right. And what’s my standard answer?

Madison: It depends.

Mike: Yes, it depends.

Madison: Nice lawyering, Mike. What’s it depend on?

Mike: Thanks, Maddie. I paid a lot for that degree. I’m always trying to get my money’s worth. I think the answer partly depends on where in the world you live. There are a lot of countries we don’t invest in purposely, because we don’t trust their markets or their governments at all. And I don’t mean that in like the vague way many distrust the US or their state or local governments. I mean that some countries are outright autocracies or kleptocracies, and they don’t care at all about governance or the rights of the finances of their citizens. So we don’t invest in those countries. And I would expect less of a home bias and would recommend against it if those people are even free enough to invest outside their countries. I wouldn’t do it. I mean, I wouldn’t invest in their countries.

Do Any of Our Listeners Live in Those Countries?

Madison: So do any of our listeners or clients happen to live in any of those countries?

Mike: Well, no, they probably don’t. I can’t say for sure about our listeners, but our clients are all US, UK and EU based.

What Should Our Listeners Do?

Madison: So what should our listeners do?

Mike: So, first, there’s no right answer, but I think there are a couple of ways of looking at it. And of course, there are pros and cons to each. If you look at global market caps, they change over time. But I think the US has the largest global market cap by far, with the EU in second and China in third. And I don’t think most people think about which of the 100 or so countries with markets they’ll invest in. It’s how much should be in a handful of other countries, or how much should be in the US versus other developed markets or funds of those markets or emerging markets.

What are Market Caps, Developed, and Emerging Markets?

Madison: So you threw out some new terms for me. What are market caps and what are you developed and emerging markets.

Mike: Sorry about that, Maddie. This financial jargon creeps up all the time. Market cap is short for market capitalization, and it’s used two ways. So a company’s market cap is how much would it cost to buy all the shares outstanding. So the current market price, whatever you could buy it for on the stock exchanges, times the number of shares that are outstanding, give you that. So if a company is selling for like $100 per share and there are a billion shares outstanding, it would cost $100 billion to buy the whole company. The market cap for a country would be determined just by adding up all of the companies in it. And so the market cap for the US is much larger than the EU, which is in second place, and then China’s third. And developed markets refer to countries that have been around for a while and have had markets and market economies for a while. And emerging markets are those that have done so more recently. So in developed markets, you think of like England, France, Germany, Italy. Emerging markets, you think more of like, India or Russia or China. For most people in the US, it’s a question really, of how much of your investment should be in the US, how much in developed foreign markets, and how much, if any, should be in emerging markets.

Why the “If Any” in Emerging Markets?

Madison: Why the “if any” in emerging markets?

Mike: Well, because of the risk and volatility of the returns. Emerging markets have the highest expected returns and we would expect they’ll have the highest growth in the future. But that means that they always seem to have the best or worst returns every year. And if someone had all emerging markets, or a big percentage, the down years might be hard to stomach. So there used to be these charts, they probably still have them. And it would show you, it was a good way of showing why you’d want a diversified portfolio of asset allocation. There would be these charts and it would have like different colored boxes and it would have like ten different markets. So it’d be like US, developed markets, small cap, growth, large, value. They would break up into like real common different market things. And it would show you, like, which had done best, like, each of the previous ten years. And if you looked at that, it really changes. And whatever does best or worst is different all the time. One thing I can remember from those, though, is that emerging markets always tended to be at the top or the bottom, right? So it’s a bumpy ride with emerging market stocks. And there’s no way. I mean, I think that will continue, at least for some foreseeable future. It may be forever, certainly more than my lifetime.

How Much Should Our Listeners Have in US vs. Foreign Stocks?

Madison: So how much should our listeners have in the US versus developed foreign stocks versus emerging market stocks?

Mike: So it really depends on the risk tolerance for how much in emerging markets. But I usually recommend like 5% to 10%. I have 10%, but I have a high risk tolerance and understand pretty well how markets work. And the day to day or even year to year swings don’t bother me at all. I use the downturns as buying opportunities and I know a lot of people say that, but that is how I feel and so it’s okay for me. As for how much US versus developed international, it probably makes sense to have more US, right, because we live, work, invest, and retire here. So usually I recommend for most people like two thirds US and versus like one third foreign. But as I always say, it depends. Again, personally, I have a little less US, a little bit more foreign than that. But that’s based on how returns have been recently. And I’m okay if my portfolio doesn’t match up closely with US stock indices. A lot of people get fixated on whether their returns correlate with the S&P 500. And I think it’s a very common thing. But it’s not really that helpful or useful because for most people with a globally diversified portfolio, the stocks in the S&P 500 should make up like 20% to 40% of their portfolio. Right. So if you just were to invest in large cap growth US stocks, then it makes a whole lot of sense to compare yourself to the S&P 500 because that’s what the S&P 500 is. But if you’re going to invest in thousands of stocks and most people also have bonds, it doesn’t make sense to just compare it against US large cap stocks. But people can’t help doing that. So if you need to really compare yourself against the US, against the S&P 500, then if the globally diversified portfolio, you’re going to be really disappointed other than the years like 2000, 2001, 2008, 2009 where the US stock market plunged. All right, so there’s more stuff to unpack here, Maddie. So like one thing is some people say to only invest in the US because America is an exceptional country. Like the people talk about American exceptionalism all the time. And look, I was grateful that I was born at the time and place, that I was out of all of history. And the US has had an amazing run. But, you know, can investors expect still getting those same returns? You know, 120 years ago we were an agrarian, sparsely populated country and in the last 100 / 120 years, we’ve had a huge amount of growth. You know, like, we were not hit as hard like World War I and World War II did not happen on our soil other than Hawaii. And so we did not have the recovery that most of the rest of the world did, and that helped us. Those things from history can’t be repeated. And what does that mean for investors? We were an emerging market economy 100 / 120 years ago, and we did really, really well for investors. Now we’re developed, shouldn’t the return expectations decrease? Also, there are political risks in investing in only one country. Hard to imagine, but there are political risks here. You know, again, people look at the US as if things can’t happen here. But, you know, other countries have been very surprised when things happen in their countries. And why can’t that happen here? I mean, we just have to go back to the, you know, we have trials going on right now over the January 6 insurrection attempt, so we can’t say it can’t happen here. So, yes, we invest more here than elsewhere, but I think it’s foolish not to think that we can’t have issues. Right? And diversification is the closest thing you’ll get to a free lunch in investing. And yes, US stocks have outperformed recently. But if you look at decade by decade returns over the last 120 years, the US has outperformed in six and foreign stocks have done better in six. The media talk about the lost decade here. From 2000 to 2010, when US stock performance was miserable, you know, in 2000 to 2002, the US stock market went down by half, you know, 50%. And in 2008, 2009, in five months, it also went down by half, 50%. So if you just had the S&P 500 and you had $100,000 in it, five months later, it’s worth $50,000. Do you really want to do that? I don’t know that most people would want that kind of risk, but that’s just me. Having money outside the US really helped them. It wasn’t a lost decade for globally diversified investors. Does that all make sense to you? Can you understand why I would invest outside the US?

Madison: Yeah. Yeah. I think you broke it down very clearly, and it definitely does make sense.

Small Cap and Value Stocks

Mike: Well, thank you. So, look, while we’re at it, and I’m on a rant, let’s also talk about small company stocks and value stocks, which many investors also forget about every year or six months or two years, there’s some stocks in the news and they become like media darlings and everybody talks about them. And if you’re talking to your neighbor in your backyard at the barbecue, they’ll say, do you own this stock or that stock? And people get wrapped up in it because it had some performance that led you to think about that. It did really well for some period. You’re like, oh, my God, do you own Tesla or Nvidia or some other company that has had some sort of meteoric rise? Here’s the thing. If that has already happened in the past, there’s no guarantee that that will happen in the future. And there’s also all sorts of other companies that don’t make headlines that do really, really well. Right. So these companies like Tesla or Nvidia. Tesla has got a CEO who loves to be in the news. Nvidia was not as well known, but in the last year had this tremendous run. And it’s great, it’s a great company. I’m happy for them. But there are hundreds or thousands of other companies that do pretty well that you don’t hear in the news and they don’t make headlines, but they’re still there. And unfortunately, too many times people get wrapped up in these growth stocks, these stories of this meteoric rise. The reality is, over the time that we have good data for, value stocks have done better. And so what’s a value stock? That is a stock that you can get at a cheaper price relative to its earnings. So a growth stock might sell for 50 or 100 times its earnings. It’s called a price earnings ratio. So if a company earns $10 a share and it’s selling for $1,000, so it’s selling at 100 PE. A value stock is one that is not necessarily in the public eye and is selling for a much cheaper price. So a PE of a value stock might be 10 or 5 or 15. Historically, despite all the media and everybody getting enamored over growth stocks, value stocks have performed better. There’s a guy named Warren Buffett who’s made a little bit of a name for himself over the last 60 years by buying value stocks. Also, again, we hear all these large cap stocks like Tesla or Nvidia. Small cap has done better than large cap over time by a lot. That one or two percentage points a year over 100 years adds up to a huge amount of outperformance. So like one example, right. So 1973 – 1974, there was a really hard bear market. Stocks went down by like half. Since then, 50 years later. Right. And so because they’re low starting points, these numbers are going to be inflated. But since then, the Nasdaq is up about 200 times in that 50 years. Nasdaq is large growth like tech stocks. Small cap value is up 2000 times during that time period. So if you think, if you get upset because a house is like twelve or 15 times more expensive than it was in 1973, invest more in small cap value stocks and you’ll be able to buy all the houses you want, Maddie. Anyway, again, I’m sorry for the rant. You just can’t help, remind people you need to be diversified. You need large and small, a little bit more value than growth and developed and emerging markets and US stocks. Thanks for letting me air all that, Maddie.

Conclusion

Madison: I got it. Thank you so much, Mike. Is there anything else that you wanted to put on top of that?

Mike: No, I think that’s it for today. I think I’m out of steam.

Madison: All right. Sounds good. All right. So for more information on Yardley Wealth Management or Yardley Estate Planning, you could visit our website at yardleywealth.net, and yardleyestate.net. You can also follow us on socials at Yardley Wealth Management. This podcast has been produced by Madison Demora and Mike Garry with technical and artistic help from Poe Productions.