Another Asset Allocation question

[downrod]

I have been trying to nail down my asset allocation and I have been reading quite a bit about it, but it is never clear to me. When they say you should have 30% in international stock. Do they mean 30% of portfolio or 30% of stock portion of portfolio. Big difference.
I looked at the Vanguard 2025 fund and it is invested 24% of total portfolio in international. Other articles suggest as much as 40% international, but they do not specify if that is a percentage of total portfolio or just a percentage of stock portion of portfolio.

Right now, I am significantly lighter than the Vanguard Target fund. I am at 13% of total portfolio in international

What would be a smart international % of total portfolio for a set and forget portfolio?

 

[pb4uski]

They mean 30% of your total stocks would be international.... actually I think Vanguard's target is 40% rather than 30%.

There is significant diversity in thinking about the need for nd amount of international stocks one should hold... ranging from John Bogle who thought it could be none to others like Old Shooter who advocate owning the world, whcih would mean about 50%.

There is no doubt that it is a diversifier, but over recent years it has also been an underperformer.

Since there is no "right" answer, I suggest that you just pick a number and stick to it.

 

[gwraigty]

What is smart is doing what you feel comfortable with, not what "they" say you should do. I don't invest based on asset allocation, and our portfolio is just fine without international stocks or bonds. I don't understand currency fluctuations and prefer not to dabble in those risks right now. If I change my mind someday, I'd start small, nowhere near 30% of anything, and see how it goes. You can always increase or decrease as desired.

 

[OldShooter]

... What would be a smart international % of total portfolio for a set and forget portfolio?

The short answer to this is "No one knows." In ten or twenty years you'll be able to look back and answer the question, but that answer will tell you nothing about the "smart" percentage for the next ten or twenty years.

Here is a short video where Ken French, genuine investment guru, deals with the question: https://famafrench.dimensional.com/videos/home-bias.aspx And here is a Vanguard paper on the subject: www.vanguard.com/pdf/ISGGEB.pdf

As @pb4 said, DW and I simply buy the world. VT/VTWAX. This way we are diversified across about 7000 stocks instead of just the 3,600 or so American ones. It is well known that betting on sectors (energy, small cap, consumer staples, etc.) can be hazardous to your financial health because nobody knows how to predict winners. So as John Bogle advised: We don't look for the needles; We just buy the haystack. Mostly for US investors this involves heavy or even 100% home country bias. DW and I see the whole world as our target haystack and believe that this diversification reduces, not increases, risk.

A few years ago I took an excellent (free) online course from the University of Geneva titled "Portfolio and Risk Management." It was excellent and I recommend it: https://www.coursera.org/learn/portfolio-risk-management It covers your question quite well and, particularly, deals with the currency risk question that @gwraigty raises.

This thread reminded me of that course. I am now going to take it again! Thanks.

 

[RunningBum]

It's definitely x% of your stocks, not of your portfolio. In less formal places like here people may talk of being "30% international" without qualifying, but any properly written piece should be more specific. For example,

https://investor.vanguard.com/investing/investment/international-investing

To get the full diversification benefits, we recommend that you consider investing about 40% of your stock allocation in international stocks

You ask:

What would be a smart international % of total portfolio for a set and forget portfolio?

That would first depend on what % of your portfolio is equities, and then whatever you are comfortable with. I go 35-40% for diversification, but I can see why others go much lower, or even 0. International has been underperforming (but does that mean it will bounce back?), and some aren't comfortable with the varying levels of regulation in reporting financials that some countries have. I'm not sure what reading to suggest, but I suggest you do your own research and decide. Asking the question here counts as research, and hopefully people will give their reasons so you can learn, but it shouldn't be your only source, IMO.

 

[downrod]

The short answer to this is "No one knows." In ten or twenty years you'll be able to look back and answer the question, but that answer will tell you nothing about the "smart" percentage for the next ten or twenty years.

Here is a short video where Ken French, genuine investment guru, deals with the question: https://famafrench.dimensional.com/videos/home-bias.aspx And here is a Vanguard paper on the subject: www.vanguard.com/pdf/ISGGEB.pdf

As @pb4 said, DW and I simply buy the world. VT/VTWAX. This way we are diversified across about 7000 stocks instead of just the 3,600 or so American ones. It is well known that betting on sectors (energy, small cap, consumer staples, etc.) can be hazardous to your financial health because nobody knows how to predict winners. So as John Bogle advised: We don't look for the needles; We just buy the haystack. Mostly for US investors this involves heavy or even 100% home country bias. DW and I see the whole world as our target haystack and believe that this diversification reduces, not increases, risk.

A few years ago I took an excellent (free) online course from the University of Geneva titled "Portfolio and Risk Management." It was excellent and I recommend it: https://www.coursera.org/learn/portfolio-risk-management It covers your question quite well and, particularly, deals with the currency risk question that @gwraigty raises.

This thread reminded me of that course. I am now going to take it again! Thanks.

Thank you for the excellent information! I will take this course

 

[OldShooter]

Glad to help, @downrod.

I just clicked into the first course lecture myself and realize that I need to warn you about one thing: In Modern Portfolio Theory, "risk" is defined as "volatility" aka "standard deviation." This is very nice for someone who wants to play with formulas and mathematics, and certainly volatility is a risk for someone who is liquidating a portfolio. But is certainly not the whole enchilada. Consider Montgomery Ward, Sears, General Electric, Enron, and various Ponzi schemes like Bernie Madoff. In fact, I would argue that for someone in the accumulation phase, volatility is irrelevant except to the extent buying opportunities can be exploited.

I'm not arguing directly with the academics here but I don't believe that MPT has to whole answer with respect to risk.

 

[easysurfer]

If this makes any sense, AA is more gut feeling and rule of thumb than strict percentage values.

Keeping the AA at a level which you feel comfortable sleeping at night is a commonly used allocation .

 

[target2019]

I have been trying to nail down my asset allocation and I have been reading quite a bit about it, but it is never clear to me. When they say you should have 30% in international stock. Do they mean 30% of portfolio or 30% of stock portion of portfolio. Big difference.
I looked at the Vanguard 2025 fund and it is invested 24% of total portfolio in international. Other articles suggest as much as 40% international, but they do not specify if that is a percentage of total portfolio or just a percentage of stock portion of portfolio.

Right now, I am significantly lighter than the Vanguard Target fund. I am at 13% of total portfolio in international

What would be a smart international % of total portfolio for a set and forget portfolio?

I use a ratio when saying it out loud, and do the hard math in a spreadsheet.
(° ͜ʖ ͡°)

Target of US Stock/Int'l in our portfolio is 2/1. But we've drifted to 2.5/1 lately.

 

[GalaxyBoy]

When I went through this exercise a few years ago I fell victim to "paralysis by analysis." I finally made a decision and stuck to it. As others said, there's no "right" answer except in hindsight, and it's probably an answer that would have looked ridiculous in foresight.

 

[pb4uski]

Another thing to consider is the placement of international stock. It is best in a taxable portfolio.... most of the dividends received are qualified, you can take advantage of long-term capital gain rates and most importantly the foreign tax credit.

If you have your international stocks in tax-deferred or tax-free then foreign taxes paid go to waste as you never get a tax benefit from them.

I hold VTIAX in taxable and the last few years the foreign tax credit exceeded the incremental ordinary tax on non-qualified dividends so my net tax was actually negative.

 

[downrod]

Another thing to consider is the placement of international stock. It is best in a taxable portfolio.... most of the dividends received are qualified, you can take advantage of long-term capital gain rates and most importantly the foreign tax credit.

If you have your international stocks in tax-deferred or tax-free then foreign taxes paid go to waste as you never get a tax benefit from them.

I hold VTIAX in taxable and the last few years the foreign tax credit exceeded the incremental ordinary tax on non-qualified dividends so my net tax was actually negative.

Great information! VTIAX is my only international holding. I have actually heard just the opposite about taxable accounts. Right now I only have VTSAX in my taxable account. I guess I need to learn more about this foreign tax credit.
Thanks so much

 

[COcheesehead]

For hints, look at some of the better performing allocation funds. A 5 star one that I follow has had international at about 5% for a long time. I followed suit and I am happy I did. International has underperformed. When they up their allocation, I will too.

 

[Navigator]

As others have stated, recommendations are for a percent of the stock portion of your portfolio. However, the term “international stocks” is quite broad. The international market can be divided into developed and emerging markets. Each of these can be further divided into large cap, small cap, value, etc. stocks. A well-designed asset allocation should have a bit of all of these in it.

You could just pick a number for the percent international stock, but the historical evidence suggests there is a better way to do this. According to Modern Portfolio Theory, there is an optimal asset allocation that maximizes a portfolio’s return for a given level of risk. A major reason for including international stocks is that they do not follow the US markets in lock step, thus reducing the volatility of a portfolio (i.e., reducing risk). For a 60/40 portfolio, this diversification historically increases risk-adjusted performance by about 0.5% per year. Over 30 years, that is about a 16% increase over a non-diversified portfolio. I would suggest using stock calculators such as Firecalc to see what results different asset allocations produce before deciding how to allocate your money.

 

[mrfeh]

The consensus over on bogleheads seems to be 20-40% of equities should be ex-US.

Of course, there is no "correct" answer. Some say 0%. If you go by global market cap, it should be 50%.

Ultimately it is your decision. The important thing is that whatever you choose, stick with it.

 

[savory]

While exact % would be hard to calculate, do you consider the international business done by USA companies as part of your international allocation?

 

[Dtail]

While exact % would be hard to calculate, do you consider the international business done by USA companies as part of your international allocation?

I don't and don't believe most folks would mathematically include this derived number as part of their Int'l allocation.
Others might say differently.

 

[OldShooter]

... You could just pick a number for the percent international stock, but the historical evidence suggests there is a better way to do this. According to Modern Portfolio Theory, there is an optimal asset allocation that maximizes a portfolio’s return for a given level of risk. A major reason for including international stocks is that they do not follow the US markets in lock step, thus reducing the volatility of a portfolio (i.e., reducing risk). For a 60/40 portfolio, this diversification historically increases risk-adjusted performance by about 0.5% per year. Over 30 years, that is about a 16% increase over a non-diversified portfolio. I would suggest using stock calculators such as Firecalc to see what results different asset allocations produce before deciding how to allocate your money.

Yes. This is really not a dartboard exercise or a matter of "taste."

The link to the University of Geneva course that I provided will dunk you quickly into MPT, but then also tell you about its many shortcomings. IMO it is a very important theory with the benefits of diversification at its heart. But I don't think it is gospel unless you also believe:

1. Standard deviation is the sole measure of risk.
2. Future growth and volatility of all asset options is known and certain.
3. Distribution of asset prices follows a normal (Gaussian) distribution.
4. Asset prices from period to period (i.e., day to day) are uncorrelated. IOW momentum does not exist.

Unfortunately, of course, none of these are true. As has been said in anther current but unrelated thread here: Everything in moderation [including MPT].

 

[OldShooter]

While exact % would be hard to calculate, do you consider the international business done by USA companies as part of your international allocation?

No. I believe that to be erroneous thinking. I will mention that University of Geneva course yet again because there the professors talk about asset correlation. An argument in favor of your thesis is that large worldwide companies in similar businesses are more correlated than smaller companies. But that is an argument that it is more important to be investing in the small less-correlated companies in order to achieve better diversification.

Also, some large international companies are in businesses that really don't have major competitors in the US. Beer, steel, and cement are (I think) in that category. The US is also somewhat underrepresented in oil, I think, compared to BP, Shell, and (soon) Saudi Aramco.

 

[Navigator]

Yes. This is really not a dartboard exercise or a matter of "taste."

The link to the University of Geneva course that I provided will dunk you quickly into MPT, but then also tell you about its many shortcomings. IMO it is a very important theory with the benefits of diversification at its heart. But I don't think it is gospel unless you also believe:

1. Standard deviation is the sole measure of risk.
2. Future growth and volatility of all asset options is known and certain.
3. Distribution of asset prices follows a normal (Gaussian) distribution.
4. Asset prices from period to period (i.e., day to day) are uncorrelated. IOW momentum does not exist.

Unfortunately, of course, none of these are true. As has been said in anther current but unrelated thread here: Everything in moderation [including MPT].

You make several good points about weaknesses in MPT, but it is still the best theory we have for explaining stock market returns. Yes, future returns may not follow historical returns due to changing laws and aging populations. Momentum is a market psychology factor. Several years ago Fama and French did add two psychology factors to their model (similar to momentum), but these only worked for US and European markets, not any others.

Having said these, MPT has been shown to work in both US and international markets. It is the best predictor of long term market behavior and we know why the factors work. There may be a lot of noise around MPT predictions, but it still the best tool we have.

 

[OldShooter]

You make several good points about weaknesses in MPT, but it is still the best theory we have for explaining stock market returns. Yes, future returns may not follow historical returns due to changing laws and aging populations. Momentum is a market psychology factor. Several years ago Fama and French did add two psychology factors to their model (similar to momentum), but these only worked for US and European markets, not any others.

Having said these, MPT has been shown to work in both US and international markets. It is the best predictor of long term market behavior and we know why the factors work. There may be a lot of noise around MPT predictions, but it still the best tool we have.

Broad brush I don't think we disagree, but I would not say MPT is necessarily the "best theory." I would say that it is a very useful theory. But like cutting tough objects with the best of the dull knives in the drawer, one has to be very, very careful.

In the same vein, IMO asset pricing models like the Fama/French three factor model are also very useful theories. Ditto the Efficient Market Hypothesis and the many entertaining points that behavioral economist Richard Thaler likes to bring up. We have many dull knives in our drawer.