Why You Should Own Foreign Stocks

Posted on July 7, 2014 at 2:09 PM PDT by

Investing is, admittedly, a difficult undertaking. You hope to make the right choices, and to grow your money without taking undue risks.

That feeling feeds a curious response, as researchers have discovered. We tend to favor stocks issued in our own country.

Of course, you might say! I feel safer knowing that my money is close to home! Besides, U.S. companies are global and well-known, and our accounting laws and judicial system are well-run.

foreign stocks

But that’s forgetting that the same thing happens in India, Japan. Russia, Brazil and nearly any place with a homegrown stock exchange. Everyone thinks companies based in their culture are superior and more trustworthy, and they tend to shun opportunities to invest abroad.

Known as “home bias,” the effect is that Americans tend to own American firms, Indians own Indian firms, and so on. The problem is, both sides lose.

Why? If you hold mostly big U.S. stocks, say the Dow industrials, you own a lot of very large, slow-growing companies. They tend to issue dividends, sure, but the upside is limited since most of the big American companies are fully grown.

You can offset this with U.S. small caps, of course, and perhaps technology stocks, but many of those firms are nevertheless geared to the U.S. economy. If the whole economy is slow, so are prospects for even the most aggressive of start-ups based here.

The foreign-country investor, if they live in an emerging country, has access to a lot of growth. Their economy is more volatile and the companies generally smaller, yet the opportunities for major growth are much greater.

That’s because these economies often have very different demographic trends: More young consumers and swaths of untapped demand. The foreign investor who sticks too close to home thus gets more growth but takes on more risk.

Perfect portfolio

The perfect portfolio, thus, owns both U.S. stocks and bonds but also a measure of foreign equities and debt.

Likewise, foreign investors should lower their volatility by purchasing stocks of large, developed country firms, if they can. Too often they can’t, and that’s a shame.

For Americans saving for retirement, however, the path is clear. Own ETFs or index funds to keep things simple, but don’t shy away from foreign stocks and bonds.

A balanced, well-designed portfolio can capture that growth at a low cost and helps us reduce the disadvantages of home bias.