It wasn’t long ago that we published our Q1 Market Update, but since then there’s been a lot happening in both the markets & in the world in general.
In today’s episode we are going to explore with you why you should look beyond the markets of your home country, or the country you’re living in now, and invest in all parts of the world. In other words, why investors should go global.
So first of all let’s talk about something called home country bias. Most of us are fond of the country we’re born in, and quite rightly so. It would be a bit odd if you didn’t support your home nation during the Olympics or any other sporting event. Some of you might also prefer to buy clothing or goods made in your home country. Home bias is this preference for things from your own country, and it also often extends to investments as well. So someone from the UK for example might invest a large portion of their portfolio in stocks listed on the FTSE 100, or people living in the US might invest mostly or even exclusively in S&P 500 companies and US government bonds.
Nothing wrong with this you might think. After all, the closer to home something is the more familiar it is, and the more comfortable it makes you feel. The trouble is, in investing you’re not rewarded for feeling comfortable. In fact, it’s often the opposite. The areas that many people overlook because they’re just too unfamiliar and uncomfortable can be some of the best performers at times. And that’s where the main problem lies. You might do well investing largely or even solely in your home market, but by expanding your horizons and opening your portfolio up to the rest of the world, you could do even better, and increase your diversification to boot.
Now unless you’re a US-based investor, the vast majority of investing opportunities will lie outside your home country. Despite having the world’s third largest stock market, the UK for example only makes up just 4% of the global stock market, yes a tiny 4%. Switzerland as another example is only 2.5%. And even if we take the entire European continent their combined stock markets only make up 15%. So if you restrict yourself to your home markets, you’re cutting yourself off from 85%, 95% or more of the world’s opportunities.
Now admittedly, in this day and age, it’s rare to see anyone with their entire portfolio invested in their home country. The exception to this is the USA but we’ll come on to that in just a moment. What is common though is to see typically around one-third to two-thirds invested at home. So if you’re from the UK and you’ve got a third of your portfolio invested in FTSE 100 companies, as I’ve seen in many portfolios managed by UK-based professionals, you’ve got around 8 times as much invested in them as their portion of the global stock market. This is called being overweight, and whether the investor intends this or not, effectively your portfolio is positioned for UK-listed investments to perform better than the rest of the world.
And it’s not just restricted to the UK. I’ve also seen this with Swiss wealth managers, French, German, Canadian, Australian, in fact pretty much everywhere you look. Is it just coincidence and they all think their country’s stocks are going to do better than everywhere else? No, it’s just home country bias, and this biased approach could be holding back their returns.
Now I said I’d give a mention to the USA, so let’s talk about that. The USA is different from the rest of the world as its stock market makes up a whopping 62% of the global stock market. So you might think US-based investors are justified in having very high exposures to the US stocks in their portfolio, and, in a way you’d be right, if their exposure was around 62% that is. The reality, however, is the average portfolio for US-based investors has 88% invested in the states. So of course it’s not as overweight as with other countries – I mean that would be impossible, you can’t invest 8 times more than 62% as that’s nearly 500%. But the point is, home country bias is a worldwide phenomenon.
Now I imagine at this point some listeners are shouting at me, “yes, but what about the foreign currency exposure you get when you invest internationally?” And this brings us onto an investing myth – and that myth is that investing in your home stock market avoids foreign currency risk. And that’s simply not true. There are two main reasons why. The first is that not all the companies that make up a country’s stock market are actually based there. Being listed on a stock market doesn’t necessarily mean those companies are based in that country. So in the USA’s S&P500 for example you’ve got companies from Ireland, the UK, Switzerland, the Netherlands, Israel and Curacao in the Caribbean. In the FTSE 100 there are businesses from Australia, Switzerland, Ireland, Spain, Luxembourg, Mexico, the Netherlands, the Czech Republic, Cyprus, I think you’ve got the point. But that’s not even the main reason why you don’t avoid foreign currency exposure by sticking with your home market.
The main reason is most companies that makes up the bulk of stock markets are large, multinational businesses, selling their goods and services around the world and therefore earning their sales and profits in many different currencies. So the companies are exposed to foreign currency, and as those companies collectively make up the market, the market is by default impacted by foreign currency too. And more than you might imagine actually. Around 30% of S&P 500 company earnings comes from outside the US. If we look at the two biggest companies on the US stock market, and indeed the world, Microsoft earns more outside the USA than in it and Apple earns two-thirds of its money abroad. If we look at the UK stock market, over 70% of earnings made by those companies come from outside the UK and the figure is even higher in the Swiss stock market for example. So it really is wrong to think investing in your home country market avoids foreign currency risk.
So, the solution to all of this is simple. Invest globally, by investing in all the major stock markets of the world and in broadly the same proportion as the global stock market. That means you’ll have around 65% invested in North America, 15% in the Europe including the UK, 10% in the developed Asia Pacific region which includes Japan, Australia and Hong Kong, and roughly 10% in emerging markets like China, India and Brazil. That way you won’t be missing out on any stock market opportunities, and you’ll be maximising the only free lunch in investing – and that’s diversification. You can’t get more diversified than the entire world.
Some US investors will point to the US stock market performing better than the rest of the world over the last 10 years, but in the last five decades that’s actually only happened twice, so it’s not a foregone conclusion the US will always come out on top. In fact from one period to the next any region could be the biggest gainer. There’ve been times when Europe has delivered the best returns, and others when it’s been Asia and others when it was emerging markets. So by investing globally you don’t have to guess which one will be top dog over the next 12 months or 12 years – and let’s not forget your predictions, or anyone else’s, could turn out to be completely wrong. Instead, by investing globally, whichever part of the world delivers the best returns will always be there in your portfolio.
OK, That’s all for today. Thanks for tuning in and I’ll see you next time.
In this series, Skybound Wealth's Head of Investments Jonathon Curtis looks at all things investing for those living outside their home country and to help you make the most of your wealth.
Jonathon cuts through the media noise to discuss topics such as: Market performance, current financial affairs, how different types of investments work, The importance of building the right portfolio, how to avoid common investing mistakes, and tell you what really matters to help you become a better investor.
This was recorded on the 31st August and all information was correct at the time of recording. This podcast is for educational purposes only and is not a personal recommendation. If you’re unsure what’s right for you, you should seek advice. Past performance isn’t a guide to the future, and investments rise and fall in value so you could get back less that you invest.
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