A record number of Americans are gearing up for an exciting foreign vacation. Still, there’s another journey they should consider embarking on—diversifying their stock portfolios beyond the confines of their home country. While the classic financial mistake of home-country bias has paid off in recent years, riding solely on the success of domestic stocks might not be the wisest choice moving forward.
Measuring success in the financial world involves more than simply looking at past performance. As Meb Faber, CEO of Cambria Investment Management, suggests, those exclusively invested in the U.S. market for the past 15 years might want to reconsider their strategy. The historic outperformance of U.S. stocks during this period should not be the sole determinant for future investment decisions.
Diversification, the age-old strategy of spreading investments across different assets and markets, is now more accessible than ever. Low-cost exchange-traded index funds provide a convenient avenue for investors to broaden their horizons. While there are minor downsides, such as potential differences in the treatment of foreign dividends and exposure to foreign currency risk, these are outweighed by the potential benefits of diversification.
The argument that borders are increasingly meaningless in the global economy holds. Even as U.S. multinationals face foreign currency risks, foreign giants with significant U.S. operations and commodity producers selling in dollars present opportunities for savvy investors. As Meb Faber emphasizes, now is the time to look beyond the domestic market and explore the remaining three-quarters of the world’s economy.
Americans, in particular, are fortunate due to the size of their domestic market, which accounts for about 60% of the global value. However, relying solely on the domestic market can limit potential returns. The cautionary tale of Japanese investors during the late 1980s serves as a reminder of the risks associated with home-country bias. Japan’s once-booming market collapsed, making it significantly cheaper than U.S. stocks decades later.
Valuations further highlight the potential opportunities abroad. U.S. stocks trade higher multiples than their counterparts in the U.K., Germany, Spain, Italy, and various emerging markets. Investors looking for bargains can find attractive options in countries like Israel, Brazil, Pakistan, and Turkey.
While investing in foreign markets may seem daunting, resist relying on active managers. Research indicates that most international and emerging market stock funds fail to outperform their respective indices. Instead, consider focusing on quality stocks, as highlighted by BlackRock’s analysis. Quality stocks, characterized by high return on equity, low earnings variability, and debt-to-equity ratios, have consistently outperformed their lower-quality counterparts.
In conclusion, it has been a fortunate decade for American investors stuck to domestic stocks. However, as the saying goes on Wall Street, it’s time to move from being lucky to being smart. Diversifying portfolios beyond borders presents an opportunity to capitalize on undervalued markets and navigate the dynamic landscape of the global economy.