The investing world is filled with "conventional wisdom." But every now and then, it's good to reexamine these beliefs/assumptions. We recently did that as it pertains to investing in foreign stocks, and were surprised at what we found.
For decades, the conventional wisdom regarding foreign stocks revolved around the following two points:
1. Foreign stocks offer great diversification benefits. The theory being that foreign markets often zig when the U.S. market zags, so this tends to balance things out and make your overall portfolio less volatile.
2. Foreign markets offer exciting growth opportunities. Why exclude half (or more) of the world's stocks from your portfolio?
A changing world?
Globalization has been one of the buzzwords of the past decade. While there are many definitions of this term, in its financial context it usually refers to the idea that the world's individual nations are becoming more interconnected. National economies used to be more isolated, and were affected primarily by local and regional factors. Today, the increasing ties of our global economy mean that what impacts one country or region tends to be felt rather quickly by many other countries and regions.
What we've seen in recent years is that when U.S. stocks have done well, so have foreign stocks, and vice versa. This is clearly reflected in the table, which shows the results of investing in SMI's two primary investing strategies over the past 10 years.
For each strategy, we've provided the year-by-year results of including the foreign component as recommended, as well as what the results would have been had an investor chosen to not include foreign (in which case the money was distributed evenly among the U.S. categories).
The table shows vividly that there hasn't been much difference between including or excluding the foreign component from these portfolios over the past decade. In fact, last year's relatively small difference in results (2.5% for Just-the-Basics, 3.1% for Upgrading) was the largest of any year in the past decade.
With any study of this sort, the specific years examined can make a big difference. So we're leery of drawing too many conclusions from this relatively short period. We did go back six more years to the beginning of SMI's good data on these strategies, and with the exception of one big year (2001) when excluding foreign really helped Upgrading, the extra years just reinforced the same conclusion: including foreign stocks hasn't made much of a difference. (Full disclosure: using the 16-year period did swing the annualized returns for both strategies slightly in favor of excluding foreign, the opposite of the 10-year period results in the table.)
But we still believe!
While the diversification argument for owning foreign stocks seems to have weakened, we tend to view that issue somewhat differently. In our view, unless adding foreign stocks is hurting our performance (or greatly complicating our investing, which it is not), we're inclined to keep them. The diversification benefit may be small, but we still believe it is a benefit worth having. (Plus, it's always possible this benefit will grow in the future, though we're not counting on that outcome.)
The main reason we continue to favor including foreign stocks is the growth argument. As more of the world's economic growth happens outside the U.S., it seems unwise to exclude this growing proportion of international businesses from our portfolios. If anything, the increasing number of growth-oriented economies internationally makes us think our proportion of foreign stocks may well increase over the years rather than decrease, though likely with significant year-to-year fluctuations.
While SMI isn't inclined to make any significant changes based on this analysis, it may have applications for some readers. Newer investors struggling to meet the minimum investment amounts for multiple funds may breathe easier skipping a foreign component initially. Other investors who either want to simplify their investing, or who are uncomfortable with the idea of foreign investing, can also take comfort in these numbers. At least in recent years, including or excluding foreign stocks hasn't changed our overall performance much.