Many experts and target date funds suggest a 20-30%+ allocation to international investments. But is this actually a wise move? Here’s what the data says about it, and how to get the most bang for your buck in pursuing an international strategy (hint: it’s not the typical global index).
If you examine any target date retirement fund or walk into the office of any typical investment advisor, odds are you’ll find yourself with prescribed a 20-30%+ allocation to international stocks. If you ask for the rationale behind this decision, you’ll hear about how an international allocation will allow you to “capture the double digit growth that developing countries are able to generate” and will give you exposure to “aggressive growth in an increasingly global economy.”
I have a bone to pick with this advice.
When you buy an everything-but-the-kitchen-sink basket of global stocks, you’ll get the winners, sure. But you’ll also get the many, many losers. What makes a good index bet is looking at the performance data of how that mix of winners and losers typically performs.
Global Funds’ Lackluster Performance
In proper index fund investing, you choose the level of your index (All public stocks in the country? Small cap vs total market? etc.) based on two things:
- Past performance data
- Your thesis for why that lens is the right way to cut the market and invest
Many of us have total stock market index funds that track the broader US stock market like VTSAX because we like the past performance data. We say we can’t pick individual winners and losers, but betting on the basket of companies at this level has done well in every period.
So what happens if we apply that same data-based framework to a global investment strategy? Below is a comparison of performance of VGTSX – Vanguard’s global index fund – versus its total US stock market fund, VTSAX.
This chart shows you what $10k invested at the beginning of the period (2007) would have netted you 11 years later. In the case of the global index fund, your $10k would have become $13.1k. In the case of the US stock market index fund, it would have become $25.7k.
The global index fund would have netted you a paltry half of what the US stock market index fund would have.
Scale those numbers up for your total investable assets. That’s $200k instead of $400k in your pocket. Or $500k instead of $1 million. All because of one decision made years ago and allowed to run its course.
You can also look at returns within different periods, such as the one, three, and five year returns:
The global index’s performance continues to look unappealing to me. Its one bright spot appears to be its one year return. In general, I prefer long-term investing strategies as should anyone who wants to build a primarily passive investing blueprint for their money. Because of this, I would hesitate to make an investment decision off of a single year’s data. While the one-year performance looks good, absent a strong conviction and thesis about global growth it’s not enough on its own to catalyze an international investment.
Based on this data, I would find it reasonable for some folks to choose to ignore international stocks completely and continue to allocate their equity exposure to a US total stock market index. After all, you will still get some exposure to global growth through US companies, who increasingly sell to a global audience and maintain global operations.
But what do you do if you believe that the US will lag behind other global competitors in future years and want to put that thesis to work? Or find the idea of emerging markets too theoretically interesting to ignore? I personally share both these views.
For those with a strong belief in global exposure, instead of choosing the global level, whose data is unconvincing at best, you can choose to zero in to a different level with more promising historical data. That paired with a well-researched thesis about what will make the future performance better than the past for foreign countries makes the idea of an international allocation reasonable.
One Possibility: A China Index Fund
If you dig into the data on what made the global index outperform the US stock market index last year, you will find that one of the star performers is China.
China is a country with 1.4 billion+ people. Its GDP growth was a blistering 6.9% in 2017 compared to 2.6% in the US. Its GDP has grown 6-15% a year every year since 1993. It has a growing middle class as the economy booms, which in turn fuels consumer spending and business growth in the country. China regularly reports a trade surplus, which means the value of the goods it’s exporting exceeds the value of the goods it is importing and consuming. It is a net producer in the global economy, an impressive feat considering how consumer appetites have grown.
Chinese Index Fund
Much like you have likely considered or are already invested in a US stock index fund, you might consider a Chinese stock index fund. One ticker I like and have spent time researching is MCHI. MCHI is an ETF managed by Blackrock which is invested in every Chinese stock that is essentially available to foreign investors. China has a restriction on foreigners owning certain classes of shares in Chinese companies. MCHI holds interests in all Chinese companies trading on Hong Kong exchanges as well as all chinese stocks offering B class shares on Chinese markets (B class being the class of shares foreigners are allowed to own).
MCHI’s index shows that the basket of Chinese stocks grew a jaw-dropping 53% last year vs VGTSX’s global index return last year of 19.8%.
Note that while the one and three year performance looks very strong, the five year looks lackluster compared to a US total stock market index fund. This is not a 100% clear decision, but if you were convinced by your thesis there is certainly a lot in recent performance data to support the idea.
I plan to put 7-10% of my portfolio in MCHI and equivalent Chinese stock index funds. Note that I do not have other significant international holdings, so this would represent nearly all the international exposure I personally choose to hold. And it is much lower than the oft-recommended 20-30% you will hear from others.
While international stocks are an appealing addition to your investment portfolio, past performance data suggests that an everything-but-the-kitchen sink approach could leave you thousands of dollars behind your peers. Selecting several promising countries to invest in may be an interesting alternative for those who feel strongly about the changing global landscape.
In general, it is my opinion that the industry pushes the wrong international products to the common investor – and in too large a quantity. By exercising your own opinion and evaluating the past performance data, you could make twice as much by keeping those dollars in higher-performing indices.
What does your portfolio currently look like? Are you considering an international allocation and if so, how are you approaching the issue?
Looking For A Way To Accelerate Your Investments?
The dashboard I use to track all my investments is Personal Capital. The service is free and allows you a single pane of glass in which to view all your investments, including your international vs domestic allocations as well as how your investments compare to benchmarks on things such as fees and expense ratios. Keep up to date on the performance of your holdings as well as how they compare to other indices.