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How much international?
Old 01-24-2004, 12:31 PM   #1
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How much international?

I ran across an interesting article by Paul Merriman recently and wanted to get others opinions on it. His contention is that in order to keep volatility down once withdrawals start that it is important to have a significant dose of international equities in the stock portion of your portfolio. The data he presents seem to bear it out, but I havent seen others recommending this much international, about 50%. Any thoughts?

Here is the link http://www.fundadvice.com/FEhtml/retirement/0306b.html

Thanks,
Alan
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Re: How much international?
Old 01-24-2004, 12:51 PM   #2
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Re: How much international?

Alan,

From the guys who brought us the Trinity Study:

Does International Diversification Increase the Sustainable Withdrawal Rates from Retirement Portfolios?, by Philip L. Cooley, Ph.D.; Carl M. Hubbard, Ph.D.; and Daniel T. Walz, Ph.D.

- Alec
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Re: How much international?
Old 01-24-2004, 12:52 PM   #3
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Re: How much international?

Up to 50% international was popular AAII?, in the early 90's.
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Re: How much international?
Old 01-24-2004, 12:56 PM   #4
 
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Re: How much international?

I have read quite a few periodicals lately advocating
a heavier emphasis on international equities. As I have
no equities in my portfolio, I can ignore this issue.

John Galt
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Re: How much international?
Old 01-24-2004, 01:09 PM   #5
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Re: How much international?

Seems vaguely familar to me - early 90's, slack economy, jobs?, dollar?

I fell for it - had up to 30% international for a brief period- Vanguard Trustee's International, plus some Europe and Pacific indexes - names may not be exact. Also was a devotee of AAII where I probably got the idea.

Today - under 10% via Lifestrategy funds- moderate plus conservative.

Today my 'opinion' leans toward letting American co's bring back overseas earnings and work the currency fluctuations for me.
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Re: How much international?
Old 01-24-2004, 01:12 PM   #6
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Re: How much international?

I see some things that make me question this prescription. 1) He only uses data from 1970 forward. It is probably difficult to find good historical data for foriegn equity investments that goes very far back, but that isn't much history to draw universal conclusions from. 2) He uses fixed inflation rather than using historical inflation numbers. I'm not sure why he would do that, but inflation during part of this time was very high and would change the results. 3) He doesn't consider an option of using some fixed investments along with a US/foriegn equity mix. That would seem like the obvious choice to consider. I would be very reluctant to make any moves in my portfolio based on this article alone.

Several years ago I remember seeing data that indicated that including 10% to 20% foreign equity in a balanced portfolio could lead to slightly higher returns with reduced volatility. The data was published by Scudder who was in the business of selling international funds, so you can take that however you want. More recently, I have read articles that claim that today, in a Global Marketplace, there is so much correlation between US and other equity markets that this strategy is of limited value.

I think it probably makes sense to put some foriegn equity in a balanced portfolio, but I keep my foriegn equity balance at about 10% of my portfolio and I'm not convinced from this article that I would be wise to change that.

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Re: How much international?
Old 01-24-2004, 01:42 PM   #7
 
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Re: How much international?

On the radio last week I heard the opinion expressed
that Americans have "too many options". This did not
necessarily refer to investments. In any case, I agree
with the overall concept. Personally, I often feel overwhelmed with information/data. The trick is to
ignore what you do not need to know. I think I'm
pretty good at this.

John Galt
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Re: How much international?
Old 01-24-2004, 04:55 PM   #8
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Re: How much international?

I would be reluctant to only hold U.S. Equities or only Int'l Equities. In the ten year periods of the 70's and 80's, the MSCI EAFE outperformed the S&P 500 by 2.95% and 4.46% annualized, respectively. Then in the 90's, the S&P 500 outperformed the MSCI EAFE by 8.94% annualized. From 1990-2003, this gap was reduced to 7.21%. The maximum return for the period 1970-2003 was a portfolio of roughly 88/12 (S&P/EAFE).

If you want to look at minimizing the volatility (as measured by variance or standard deviation) of your portfolio: in the 70's the minimum variance portfolio was around 74/26 (S&P/EAFE); in the 80's it was 89/11 (S&P/EAFE); in the 90's it was 66/34; and for the entire period [1970-2003] it was 80/20 (S&P/EAFE).

I've heard the argument that globalization (or whatever you want to call it) will make equities of different nations and regions more correlated, and therefore lessen the diversification benefits.

I find a couple of problems with this. First, there have been periods in the past when U.S. and foreign Equities were both highly and lowly correlated. We could just be in a period of high correlation b/w the S&P and MSCI EAFE. Second, there is no evidence of gradually increasing correlations as globalization has gradually increased (assuming it has). A recent spike in correlations could be absolutely meaningless. Humans tend to see patterns in things where the pattern can't be distinguished from pure chance (or the flip of a coin).

We simply do not know which region/country/etc. will perform the best in the future. If you choose to only focus on one country (even the U.S.), you could end up with the highest, or the lowest returns. And since people tend to hate losses more than value gains (of equal amounts), I'd tend to favor reducing the lowest returns risk. Holding int'l equities (non-hedged) provides currency diversification, reducing the risks of holding all your asset denominated in one currency. Some of the best diversifiers of U.S. stocks have been int'l small caps and emerging market stocks.

Of course, all of this is just focusing on minimizing Non-systematic risks (e.g. firm/industry/country specific risks). Worldwide economic events (like the Great Depression or periods like 1973-1974) can always affect all or most risky assets. I think Systematic risks (market or macro risks) can only be reduced through less risky investments like ST/IT bonds.

[note: I calculated the above numbers in Excel, and I think that they're right since they jibe with what I've read on the subject]

- Alec
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Re: How much international?
Old 01-25-2004, 04:26 AM   #9
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Re: How much international?

What's American? The two extreme agruments periodically surfacing from the 80's and 90's that I remember - were the previously posted up to 50% international and the other one, the S&P 500 has foreign earnings(up to 40% at times) so let the individual co,'s work the currency hedging problem.

Then framed in various risk/reward agruments select various overseas funds either based on what's cheap or growth depending on if you're trying to damp risk or improve overall portfolio performance.

After being up to 30% int'l (early 90's), I basically opted out and bought Vanguard Lifestrategy( roughly 60/40) which has 10% total international - Why 10%, they didn't tell me and I haven't asked.

Hope more poster's weigh in on this because I've yet to resolve how to view international exposure in my own mind.
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Re: How much international?
Old 01-25-2004, 05:53 AM   #10
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Re: How much international?

Quote:
1. I've heard the argument that globalization (or whatever you want to call it) will make equities of different nations and regions more correlated, and therefore lessen the diversification benefits.

2. Humans tend to see patterns in things where the pattern can't be distinguished from pure chance (or the flip of a coin).

We simply do not know which region/country/etc. will perform the best in the future. If you choose to only focus on one country (even the U.S.), you could end up with the highest, or the lowest returns.

3. Holding int'l equities (non-hedged) provides currency diversification, reducing the risks of holding all your asset denominated in one currency.

4.Some of the best diversifiers of U.S. stocks have been int'l small caps and emerging market stocks.
1. I am one of the people who believes that markets (especially of the U.S. and other "developed" countries)are likely to continue being more highly correlated. I agree with point #2 as a general principle, but I don't think that it applies here. In the U.S. and elsewhere, international trade as a percent of GDP is rising -- largely through the rise of multinational companies whose profits depend on international economic conditions.

It is true, of course, that the U.S. market will never be perfectly correlated with any other, and this guarantees that international diversification will reduce volatility. What a lot of people apparently don't understand, however, is the statistical fact that two variables (such as the annual return on stocks of two countries) could be perfectly correlated, and yet the mean of each could be completely different. Without being a flag-waver, I think that the U.S. continues to have fundamental economic advantages that will cause the future returns on its stocks to exceed those of most other developed countries. A few might beat it (particularly Japan for a temporary period if it finally gets its economic act together) but over the long term I can't imagine other developed markets as a group beating the U.S.

3. Unless you are heavily dependent on foreign sales or purchases in your business, currency fluctuations are not something that affects you all that much. If they are, you can control that risk with futures contracts on currencies.

4. I think that emerging markets offer the best chance of out-performing the U.S. stock market. They too offer some diversification but are prone to severe crashes that sometimes coincide with those of the U.S. market. So I would limit my allocation to those to 10% AT MOST. Another disadvantage is that the expenses of most emerging market mutual funds are around 2% per year. Vanguard's Emerging Markets Index Fund is the only one that I know of that has an expense ratio less than 1%, and it seems to perform quite well despite its lack of "active management" in markets that are supposedly "not efficient."
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Re: How much international?
Old 01-25-2004, 08:42 AM   #11
 
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Re: How much international?

Hello Jarhead! That was it for me too, ie. "Knew how to make money but not how to passively invest", or maybe
it was that I knew how to make money but didn't really think about passive investing?? Whenever I am tempted
to call my good fortune "dumb luck" I recall one of my
core beliefs.......To a large extent we make our own luck,
just as everyone knows you can be your own worst enemy.

John Galt
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Re: How much international?
Old 01-25-2004, 09:25 PM   #12
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Re: How much international?

I have some international funds that I am looking to shift to index funds. My original thoughts were 30% of my equity portfolio (which is targetted to be 80% of my overall portfolio). The breakdown I started with was

International - 30%
Large value 10%
Small 5%
Small value 10%
Emerging markets 5%

I wasn't sure I wanted it to be 30%, and was thinking that might be a little high. I haven't finished deciding what the mix should be, but my notes (updated more than a month ago) currently indicate that my last thoughts were 5% europe, 5% far east, 5% emerging markets, and 5% unknown yet for a 20% total. Why those? Well I couldn't find index funds for small/large categories outside of DFA, and I guess regions sounded like a way to allocate. Why 5%? no good reason, other than 5% is a nice round number. I'm not sure that a bunch of analysis ala expected return, standard deviation, etc. would improve on it much, and I'm not looking to become an expert in mathamatical analysis of asset allocation.

I plan on looking thru the international index funds and ETF's more carefully in March. (Feb is tax and college stuff month). Based on what I can find out about the composition of them, I'll carefully consider the alternatives, then probably flip a coin and pick some. Any comments on how to distribute the 20% international are welcome. And I may push it up to 25% (which is 20% of total portfolio)

So, I'm targetting the 20% to 30% number, and buying into the belief that it will help stabilize returns by diversifying the portfolio. The number and belief is after reading a number of library books on investing that stress MPT, and describe allocations.

Wayne

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