Author Topic: Diversify with international stock or ex-S&P500?  (Read 6848 times)

El Gringo

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Diversify with international stock or ex-S&P500?
« on: April 29, 2014, 11:29:23 AM »
I知 looking for advice on how to properly diversify my funds. I知 27 years old and very aggressive. Currently ~63% of my portfolio is in my 401k and 37% is in my IRA. Unfortunately the selections in my 401k suck, so I致e put 100% of my 401k money into an S&P500 fund. I知 then using my Vanguard IRA to diversify. My dilemma is whether to focus diversifying on other US segments of the market (mid and small cap) or international markets.

This is my current breakdown:

US Stock: 72.69% (~63% of this being from my S&P500 401k fund)
   -Large cap: 53.94%
   -Mid cap: 13.1%
   -Small cap: 5.59%

International: 20.38%
   -Developed: 14.92%
   -Emerging: 5.45%

Alternatives (REITs): 5.16%

Cash: 1.74%

The problem is that I feel I知 overweight in US stock (vs. international) but I also feel that within US stock, I知 overweight in large cap (vs. mid and small). I can either buy more VXUS and VWO to increase my international exposure and stay overweight towards large cap WITHIN my US stock or I could buy VXF and VB to increase my US exposure to mid and small cap (and become more overweight on US stock) (Also, I would probably buy just VXF as small caps seem to currently be valued pretty high). Which do people suggest I do? Or should I just continue to buy *both* international and non-S&P500.

matchewed

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Re: Diversify with international stock or ex-S&P500?
« Reply #1 on: April 29, 2014, 11:34:27 AM »
Nobody can really answer this for you as you need to come up with an Asset Allocation that suits your investing needs.

Standard advice of needing an investment policy statement. And if you haven't read jlcollinsnh's stock series it is probably a good idea.

That aside I view it this way. Companies that are large enough to be in the top 3000 companies in the US are probably doing international business and have international customers. I'd focus on diversifying my capitalization size before an international fund.

nereo

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Re: Diversify with international stock or ex-S&P500?
« Reply #2 on: April 29, 2014, 11:46:13 AM »
Hello Gringo

First off, understand that, in the historical sense of the word, you are already very diversified.  Diversity used to be used to urge investers to buy stocks in multiple sectors.  Today, if you own just the SP500 you shares of 500 different companies across virtually every market sector.  It's estimated that it alone has 80% market coverage.  Adding to that, many of the largest companies in the SP500 make a large portion (often the majority) of their income outside the US (think Apple, Coke, GM, McDonalds, etc. etc.)  In that regard over a quarter of all profits from holding the SP500 come internationally.  In a sense you already have far more than your estimated 20.38% invested 'internationally', even though you are holding a lot of US companies.

A better question to ask yourself is how do you want your money invested?  Historically US Small-cap stocks have had greater volatility and slightly better returns that US large-cap stocks.  OTOH, Large-cap stocks pay larger dividends.  Who knows what will play out in the future.
There's certainly a lot more potential for growth in emerging markets, but many of these markets are fraught with political turmoil and instability.  You could invest heavily in stocks from country X only to have a coup seize power of all private industry.  It's happened before, and it will happen again... the question is just where and when.

Personally, I don't think you are overweight in US stocks.  You've got some dedicated international funds and some additional international exposure by holding large internatinoal US companies in your SP500.  But if you feel you want to hold more international stocks, by all means do so - just consider the fees first (which will likely be higher) and know that the less stable the country, the greater the risks.

EDIT:  what you aren't doing currently is diversifying outside of stocks.  Historically stocks have generated the best yields over time periods >12 years in virtually all cases.  It's where I park 90%+ of my savings.  But diversifying also can include bonds, gold, REITs (of which you have a small percentage), and various currencies.  Each can do something slightly different in different market conditions.
« Last Edit: April 29, 2014, 11:49:26 AM by nereo »

milesdividendmd

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Re: Diversify with international stock or ex-S&P500?
« Reply #3 on: April 29, 2014, 12:07:54 PM »
I agree with the aforementioned wisdom that the most important decision is to come up with an investing style that matches your own style and values.

That being said, it's tough to have an opinion without reading some books.

I'm a big fan of Larry Swedroe and William Bernstein  personally if you are looking for authors to check out of your local library.

My 2 cents as they pertain to my own investment philosophy are as follows:

  • Diversification of asset classes is a good thing because when you mix asset classes with positive expected returns and imperfect correlations you get improved expected returns with LESS risk due to increased porfolio efficiency. (this is because volatility takes away more wealth on the downside than it creates on the upside...

    International diversification is a great idea.  Since the world economy is approximately 50% non US companies, you could make a compelling argument to have 50% of your funds international.  I have about 40% of my equities internationally allocated because US funds (like VTI and VO) are  cheaper.  And despite the presence of multinational companies in US indices, there remains an imperfect correalation of US and Foreign indices,

    A sliver of emerging markets is a good thing in any portfolio.  because they have Imperfect correlation and higher expected returns than the broad US market.  I like between 5 and 10 % EM.

    Don't forget small cap value funds.  (I love RZV.)

    REITS are another asset class to consider as a diversifier in your retirement accounts.

All That being said, there is nothing wrong with owning just VTI or VTSAX and a sliver of short term treasuries, and calling it a day.  Simple and easy and effective.

Good luck

Alexi


Grateful Stache

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Re: Diversify with international stock or ex-S&P500?
« Reply #4 on: April 29, 2014, 04:59:11 PM »
I知 27 years old and very aggressive.

Perhaps you should talk to a counselor? Maybe get into an anger-management program?




Sorry. I couldn't resist. You actually look fairly well-diversified to me in terms of your equities. I believe Vanguard recommends starting with a 20%-30% international distribution, so you're right in the ballpark (source: "Considerations for investing in non-U.S. equities" a Vanguard publication). I agree with others: check out Bernstein, Swedroe and Ferri.

Cheers. 
« Last Edit: April 29, 2014, 05:22:33 PM by Grateful Stache »

hodedofome

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Re: Diversify with international stock or ex-S&P500?
« Reply #5 on: April 29, 2014, 08:52:59 PM »
FWIW, the US is pretty much the most expensive country in the world relative to all the others. It's also outperformed most other countries the past 5 years. Mean reversion anyone?

clifp

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Re: Diversify with international stock or ex-S&P500?
« Reply #6 on: April 30, 2014, 04:33:46 AM »
FWIW, the US is pretty much the most expensive country in the world relative to all the others. It's also outperformed most other countries the past 5 years. Mean reversion anyone?

I think 20% international is fine. I 'd concentrate on small cap. 

One of the reason people make statements like the US market is expensive compared to the rest of the world, is they seem to think the S&P 500 is made of US companies.  It is not, the S&P consists almost entirely of multinational companies that happened to be started in US.  The Turkish CEO of Coke, or the Indian woman who runs Pepsi, or the fact that GM sells more cars in China,than North America, or that 75% of Intel's sales are overseas, while 75% of the manufacturing in in the US should give one an idea of the global nature of the S&P 500.

In 2012 46.6% of sales of the S&P were international, sometime in the next year or two, more of the sales will be international.  Perhaps more importantly the majority of profits for the S&P 500 have been overseas for many years. The developing economies continue to grow at rapid pace,which enable S&P500 companies to wrack up impressive profits even though the US economy is not doing well.

hodedofome

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Re: Diversify with international stock or ex-S&P500?
« Reply #7 on: April 30, 2014, 08:03:45 AM »
FWIW, the US is pretty much the most expensive country in the world relative to all the others. It's also outperformed most other countries the past 5 years. Mean reversion anyone?

I think 20% international is fine. I 'd concentrate on small cap. 

One of the reason people make statements like the US market is expensive compared to the rest of the world, is they seem to think the S&P 500 is made of US companies.  It is not, the S&P consists almost entirely of multinational companies that happened to be started in US.  The Turkish CEO of Coke, or the Indian woman who runs Pepsi, or the fact that GM sells more cars in China,than North America, or that 75% of Intel's sales are overseas, while 75% of the manufacturing in in the US should give one an idea of the global nature of the S&P 500.

In 2012 46.6% of sales of the S&P were international, sometime in the next year or two, more of the sales will be international.  Perhaps more importantly the majority of profits for the S&P 500 have been overseas for many years. The developing economies continue to grow at rapid pace,which enable S&P500 companies to wrack up impressive profits even though the US economy is not doing well.

I understand what you are saying. However, you can't fake financial ratios (unless you're messing with the books...). And those say that US companies are more expensive than international companies. If other countries are cheaper, and cheapness determines future returns, why wouldn't you want to go where it's the cheapest? Why overweight the most expensive?

nereo

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Re: Diversify with international stock or ex-S&P500?
« Reply #8 on: April 30, 2014, 10:51:46 AM »

I understand what you are saying. However, you can't fake financial ratios (unless you're messing with the books...). And those say that US companies are more expensive than international companies. If other countries are cheaper, and cheapness determines future returns, why wouldn't you want to go where it's the cheapest? Why overweight the most expensive?

First off, which "ratios" are you referring to, precisely?  Different people conclude different things depending on which metrics they are using.

As for the broader topic of being "cheap", there are essentially only two ways that a company can be "cheap" to buy.  Those are 1) the company itself is being undervalued compared to its peers.  This is the essence of value investing   2) there is more uncertainty ("risk") involved with that company than others.  One or both of those factors may be at work.
The term "international" is very broad.  Investing in developed countries like Canada or the UK probably aren't much riskier than investing in a US company. However, stocks in companies from these nations are (overall) as expensive as US companies of similar caliber.  That's market efficiency at work.
But a lot of people seek out the "cheapest" markets by investing in less stable regions.  Those companies trade at a discount because the countries they operate out of are considered less stable than their peers.  In plain english - there's more perceived risk there!

hodedofome

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Re: Diversify with international stock or ex-S&P500?
« Reply #9 on: April 30, 2014, 02:29:41 PM »
I prefer market cap/GNP or the Shiller's CAPE ratio, but price/book or price-dividends is fine too.

http://www.gurufocus.com/global-market-valuation.php
http://online.wsj.com/news/interactive/BUBBLE20131116?ref=SB10001424052702303559504579197830356373734
http://seekingalpha.com/article/2025381-lessons-from-robert-shillers-cape-ratio

I'm not saying everyone needs to turn into a Graham global value investor. But the OP is saying he's concerned about being overweight US stocks, and there's plenty of advice on this forum to be 100% invested in US stocks. I'm just giving the other side of the argument here.

clifp

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Re: Diversify with international stock or ex-S&P500?
« Reply #10 on: April 30, 2014, 04:38:43 PM »
I prefer market cap/GNP or the Shiller's CAPE ratio, but price/book or price-dividends is fine too.

http://www.gurufocus.com/global-market-valuation.php
http://online.wsj.com/news/interactive/BUBBLE20131116?ref=SB10001424052702303559504579197830356373734
http://seekingalpha.com/article/2025381-lessons-from-robert-shillers-cape-ratio

I'm not saying everyone needs to turn into a Graham global value investor. But the OP is saying he's concerned about being overweight US stocks, and there's plenty of advice on this forum to be 100% invested in US stocks. I'm just giving the other side of the argument here.

I agree with you that in general the US market is expensive on relative basis. I personally have been upping my exposure to emerging markets and international, but like the OP it is in the 20% range.  63% of his assets are in S&P 500 which is 1/2 foreign.  So 20% international +31% from the S&P roughly 1/2 the sales and probably more than 1/2 the profits are from international growth. That seems like plenty for a US citizen.

I think the higher quality of US firms and greater transparency of our financial reporting means there is lower risk..   For example I  trust that Exxon accounting a lot more honest than say Russia's Gazprom so I'm will to pay more of a dollar for Exxon's earning than Gazproms.

milesdividendmd

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Re: Diversify with international stock or ex-S&P500?
« Reply #11 on: April 30, 2014, 10:24:39 PM »
This argument that by investing in US large cap companies (ie S&P or VTI) you are getting sufficient international exposure leaves me a bit cold.

The fact remains that despite the presence of multinationals in the S&P, there is imperfect correalation of the S&P with ex-US indices.  Just look at the last 12 months.  The S&P is up 20.3%, while international large caps are up 12.6% (with more volatility).  There is imperfect correalation

Sometimes the US outperforms, and sometimes the internationals outperform.  This imperfect correalation suggests that there will be a decrease in portfolio volatility of you own both domestic and foreign indices.  This increased efficiency should improve actual returns over the long term.

As I would lay it out there are advantages to both approaches:

Owning just US funds
- Slightly lower expense ratios
- keeps it simple

Owning US and international funds
-Diversification benefit (higher expected portfolio returns due to higher efficiency/lower volatility)
-Better ability to truly "own the haystack" (the world economy is 50% non north american.)

Finally comparing Exxon to Gazprom is a misleading comparison as Gazprom would not be included in an ex-US developed market index.  Russia is an emerging market.  BP or Shell would have been closer to the mark.

-Alexi

clifp

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Re: Diversify with international stock or ex-S&P500?
« Reply #12 on: May 01, 2014, 03:10:35 AM »
This argument that by investing in US large cap companies (ie S&P or VTI) you are getting sufficient international exposure leaves me a bit cold.

The fact remains that despite the presence of multinationals in the S&P, there is imperfect correalation of the S&P with ex-US indices.  Just look at the last 12 months.  The S&P is up 20.3%, while international large caps are up 12.6% (with more volatility).  There is imperfect correalation



Where did I make the argument that he should have only US stocks?. 
The question is given additional dollars where is he better off investing the money. More international stocks or more small and mid cap stocks?
First of all if any of us knew for sure,we'd be richer.

Second 20% is well within the normal range of suggested AA for when you add that to the amount of international sales of the his over weighted S&P 500 he has plenty of exposure to growth in global markets.

Third, he is a self described aggressive investor.  Over the last 10 year the Russell 2000 has had annual returns of 9.1% vs MSCI EAFE and S&P 500 both at 7.4% at a cost of higher volatility.  That sounds like a trade off he is willing to make.

hodedofome

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Re: Diversify with international stock or ex-S&P500?
« Reply #13 on: May 01, 2014, 08:53:50 AM »
There is also Home Country Bias http://www.investopedia.com/terms/h/home-country-bias.asp, which we should all be aware of

milesdividendmd

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Re: Diversify with international stock or ex-S&P500?
« Reply #14 on: May 01, 2014, 09:09:59 AM »
Quote
Where did I make the argument that he should have only US stocks?. 
The question is given additional dollars where is he better off investing the money. More international stocks or more small and mid cap stocks?
First of all if any of us knew for sure,we'd be richer.

Second 20% is well within the normal range of suggested AA for when you add that to the amount of international sales of the his over weighted S&P 500 he has plenty of exposure to growth in global markets.

Third, he is a self described aggressive investor.  Over the last 10 year the Russell 2000 has had annual returns of 9.1% vs MSCI EAFE and S&P 500 both at 7.4% at a cost of higher volatility.  That sounds like a trade off he is willing to make.

Clif,

I was not intending to argue with any point that you made actually (aside from the Gazprom thing!). I tilt my own portfolio towards value and small stocks. So we're on the same page there.

I was merely challenging The pervasive argument that's made that by holding the whole stock market (like VTI) one has already tapped the diversification benefits of owning international funds due to the presence of multinationals.

There are great merits to simplicity in a portfolio, and I don't argue with anyone who simply wants to own bonds and the whole market. I've certainly got no problem with holding 20% international Funds.
 Alexi

matchewed

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Re: Diversify with international stock or ex-S&P500?
« Reply #15 on: May 01, 2014, 09:18:08 AM »
Quote
Where did I make the argument that he should have only US stocks?. 
The question is given additional dollars where is he better off investing the money. More international stocks or more small and mid cap stocks?
First of all if any of us knew for sure,we'd be richer.

Second 20% is well within the normal range of suggested AA for when you add that to the amount of international sales of the his over weighted S&P 500 he has plenty of exposure to growth in global markets.

Third, he is a self described aggressive investor.  Over the last 10 year the Russell 2000 has had annual returns of 9.1% vs MSCI EAFE and S&P 500 both at 7.4% at a cost of higher volatility.  That sounds like a trade off he is willing to make.

Clif,

I was not intending to argue with any point that you made actually (aside from the Gazprom thing!). I tilt my own portfolio towards value and small stocks. So we're on the same page there.

I was merely challenging The pervasive argument that's made that by holding the whole stock market (like VTI) one has already tapped the diversification benefits of owning international funds due to the presence of multinationals.

There are great merits to simplicity in a portfolio, and I don't argue with anyone who simply wants to own bonds and the whole market. I've certainly got no problem with holding 20% international Funds.
 Alexi

No where did anyone say that holding a total market equals the same diversification that holding a total market and an international market would give you. That being said the argument is that holding a total market is diversified enough for beginners and possibly for anyone who is looking to keep a simple portfolio. Holding the entire US market gives you the biggest companies, the most companies within a simple single fund, and almost all of them do international business.

RapmasterD

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Re: Diversify with international stock or ex-S&P500?
« Reply #16 on: May 04, 2014, 05:20:38 PM »
I used to own explicit international funds. I no longer do. It was all part of my simplification effort. When I see U.S. total stock market index ETFs and international total stock ETFs move up and down pretty much in tandem, particularly during the 2008 period, that doesn't spell "diversification" to me. It just spells more of the same, albeit at lower or higher positive or negative returns.

Therefore, the bulk -- not all -- of my stock holdings is in SPY (S&P 500 index ETF). As others like nereo have said, the international exposure of a typical S&P 500 company is huge. Listen to a typical investor call from a GE, an Oracle, a McDonald's. Pay close attention to the percentage of revenues that come from outside the U.S. and their discussion of the effect of currency fluctuations on their revenues.

In 50 years, if/when China is REALLY kicking ass and taking names , a different strategy may be called for.
« Last Edit: May 04, 2014, 05:33:23 PM by RapmasterD »