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Tag: international investing
A Closer Look at Global Diversification
We frequently mention the importance of employing global diversification to manage investment risks while pursuing expected returns. The broad concept is simple: Don’t put all your eggs in one basket.
That said, beyond the simple adage, questions may remain. A recent Dimensional Fund Advisors paper addressed one of them: Since U.S. stocks have outperformed international and emerging markets stocks over the last several years, is it still worthwhile to invest worldwide?
If you’d rather skip to the compelling conclusion, the short answer is, yes, global diversification is still worth it. Not only do the last several years tell us nothing about the next several years, they could lull U.S. investors into a false sense of home-biased complacency. To emphasize this point, we need only point to the 2000–2009 “lost decade,” when the S&P 500 took a depressing 10-year dive, while most of the world’s indexes soared.
Bottom line: You never know where your next source of best returns will be found, so it’s best to go global – and stay that way.
Going Global: What Does It Really Mean?
When we talk about evidence-based investing, we often mention the importance of going global.
Global diversification ensures that you aren’t placing all of your financial faith in the fate of any one country’s concentrated risks. It also helps you combat your natural tendency to bulk up on investments closer to home, where you imagine you’ll be safer or better off over the long haul.
That’s known in behavioral finance as “familiarity” or “home-town” bias, and it’s premised on false assumptions. We’re as patriotic as the next Americans. But the evidence still informs us that human commerce knows few borders, so neither should our investments.
That’s the long view on global diversification. But have you ever wondered about some of the details?
Say, for example, you were to invest half of your portfolio in a U.S. equity index fund, and the other half in an international index fund, “ex-U.S.” In terms of number of stocks as well as market cap (the total dollar value of a public company’s outstanding shares), how diversified are you, really? Are you still at a 50/50 split?
Dimensional Fund Advisors recently published “Going Global: A Look at Public Company Listings,” to explore some of these underlying questions. Some of its findings:
- Worldwide, there are more publicly traded stocks than their used to be, increasing from about 23,000 to 33,000 between 1995 and year-end 2016.
- In the U.S., there are fewer publicly traded stocks than their used to be. Using the Wilshire 5000 Total Market Index as a benchmark, U.S. stocks declined from about 5,000 to 3,600 companies between 2005 and year-end 2016. (That’s right, the “Wilshire 5000” actually only tracks about 3,600 stocks these days.)
- As measured by market cap, the U.S. still dominates global markets – by far, at 54% of the world’s market cap. That’s also an increase from 40% in 1995. The next biggest contender? Japan at 8%. (See our accompanying “Illustration of the Month.”)
- Many index funds only expose their shareholders to a fraction of these total available stocks. From Dimensional’s report: “For example, one well-known global benchmark, the MSCI All Country World Index Investable Market Index (MSCI ACWI IMI) contains between 8,000 and 9,000 stocks. … For comparison, the Dimensional investable universe, at around 13,000 stocks, is broader.”
What can you draw from these insights besides trivia to share at your next social gathering? Zooming back to our favorite vantage point – the Long View – there are still plenty of opportunities in plenty of places to maintain your efficient, effective, globally diversified investment strategy.
Illustration of the Month: Going Global by Market-Cap
As we explored in our accompanying article, “Going Global: What Does It Really Mean,” we are a huge part of the world when viewed by market cap, as the slide below shows. Thinking only in terms of landmass can distort investment decisions. Directly comparing the markets of nations produces some surprising results. Measures such as population, gross domestic product, or exports do not directly indicate the size or suitability of investments in a market.
This slide (one of our favorites) illustrates the balance of equity investment opportunities around the world. The size of each country has been adjusted to reflect its total relative capitalization.
Of course, the world is in motion—there is no fixed relationship between markets, and their proportion can change over time. Viewing the world this way brings the scope of diversification into new light and helps clarify allocation decisions.
A country’s equity market capitalization, or market cap, reflects the total value of shares issued by all publicly traded companies and is calculated as share price times the number of shares outstanding.