International Stock Allocation Question... again...

[DawgMan]

So I know the question of "what international stock allocation should I have" gets batted around here from time to time, but as I finish my rebalancing, I always seem to struggle here. I am 12 months away from my "plan" to RE (should I choose to or the markets not blow up on me) and I find as each year passes and I reevaluate my AA, I get somewhat more conservative as I have bought into the philosophy of "if you have won the game, why keep on playing". That said, at this point, I feel I will ride off into the sunset with a 60/40 AA and maintain that for the foreseeable future. While my AA generally stays set every year at 60/40, I tinker some with what makes up the stock/bond allocations. Like many, I rely on the calculators/simulators that use past history and perhaps some temperament on future returns to help set my path moving forward each year. As it relates to the international stock allocation portion, I get both arguments... 1) US stock allocation gives you enough international exposure by itself or 2) a 15% - 25% international allocation is recommended in this world economy. As I get older, I tend to lean towards 1) and currently hold about 10% in international thinking I may just want to stay there and further raise my US allocation. Yes, US CAPE is high and international stocks have been beaten up lately making them look like a better buy, but I tend to think based on my end game there is less long term risk in staying more heavily weighted in US stocks than increasing my exposure to international.

Has anyone put some the indexes next to each other comparing long term returns? Eg. S&P, DOW, Nasdaq, Large/Small Foreign, Emerging Market indexes in a pretty side by side chart showing returns/volatility?

Aside from most of the "professional" AA advice recommending a portion in international stocks for diversification, give me your arguments for 1) or 2), especially if you are in/about to retire.

 

[USGrant1962]

I struggled with this for a while.

Mathematically, U.S. companies are currently about 55% of world equity market value. So you could start there. OTOH, as you mention, U.S. companies include foreign exposure, and some folks say "that is enough". How do you know it is enough? It is not 45%.

Also, as you mentioned, today U.S. markets are richly valued per CAPE10 and other measures while most foreign markets are more reasonably valued by those measures.

Finally, how do you define risk and why do you think a less diversified portfolio (more heavily weighted in U.S. stocks) has less long-term risk? A total market-weighted portfolio (55/45 U.S./international) by definition eliminates both single-country risk and individual stock risk.

I've seen studies that concluded that something like 30-40% international exposure has historically provided most bang-for-the-buck. Figure 3 of this study shows an example for volatility: https://personal.vanguard.com/pdf/ISGGEB.pdf

So while academically a 55/45 equity AA is "correct", I'm not using it

As a compromise among the items above and my own home country bias, I'm at 60/30/10 U.S./International/REIT for my equity allocation*. This is Rick Ferri's Core-4 (the older simpler version) and for me it represents an easy-to-remember, comfortable AA with some logic behind it.

So 60/40 equity/FI becomes 36 U.S. / 18 Int. / 6 REIT / 40 FI.


*Side Note: REITs are something like 3% of the U.S. stock market but Real Estate as a whole is worth way more than that with most of it being private, hence the REIT tilt to partially make up for that and for some further diversification.

 

[Shredder]

Forgetting all the charts and numbers, I see diversification as a good thing. Whether its stocks vrs bonds or domestic vrs international. I have no idea of what the future holds, but international funds have helped my bottom line several times in the past.

I use vanguard international growth, (I used to split that with international value) and I'm switching from vanguard Wellesley to the international version.

I can sleep at night, and don't have that out on a limb feeling at all. Especially since in total I'm 50/50 stocks and bonds. 64 yr old and retired in 04.

 

[OldShooter]

... give me your arguments for 1) or 2), especially if you are in/about to retire.

(We are retired and have a passive investment strategy based on the wisdom of experts like Eugene Fama and Kenneth French. Our portfolio is approximately 50% US total market and 50% international, reflecting the fact that the US market cap is about 50% of the world market cap. Our single biggest holding is VT, which represents all the stocks in the world, market cap weighted)

To your question:

1) IMO that is a silly argument. Turn it on its head and observe that companies like Shell Oil, Nestle, and SAB Miller do a large fraction of their business in the USA. Would you say that holding a portfolio of overseas companies like these (Holland, Switzerland, South Africa) is equivalent to holding the US market portfolio? I don't think so.

2) Recommendations are like noses; everyone has one. 30% international seems to be a popular number for US portfolios. There is a good Vanguard paper here: https://www.vanguard.com/pdf/ISGGEB.pdf where their data argues that 30-40% is the sweet spot for minimum equity portfolio volatility. While I don't totally buy the argument that volatility = risk, their paper is worth considering.

For an excellent discussion of home country bias in only 8 minutes you should absolutely listen to Dr. French here: https://famafrench.dimensional.com/videos/home-bias.aspx I recommend stopping the video near the beginning just after they are done talking about Canadian investors' home country bias. See if you think that bias is wise and if not, why not? Then listen carefully towards then end where French talks about his personal investments.

(One thing that even most random-walkers agree on is the tendency of a data series to regress to its mean. If you believe that, and understand that the US markets are above historical mean and the international markets are below mean, it might cause you to believe that the international sector will, sometime in the future, be the place to be.)

So ... all that typing and no clear answer for you. Life is like that sometimes.

 

[DawgMan]

I struggled with this for a while.

Mathematically, U.S. companies are currently about 55% of world equity market value. So you could start there. OTOH, as you mention, U.S. companies include foreign exposure, and some folks say "that is enough". How do you know it is enough? It is not 45%.

Also, as you mentioned, today U.S. markets are richly valued per CAPE10 and other measures while most foreign markets are more reasonably valued by those measures.

Finally, how do you define risk and why do you think a less diversified portfolio (more heavily weighted in U.S. stocks) has less long-term risk? A total market-weighted portfolio (55/45 U.S./international) by definition eliminates both single-country risk and individual stock risk.

I've seen studies that concluded that something like 30-40% international exposure has historically provided most bang-for-the-buck. Figure 3 of this study shows an example for volatility: https://personal.vanguard.com/pdf/ISGGEB.pdf

So while academically a 55/45 equity AA is "correct", I'm not using it

As a compromise among the items above and my own home country bias, I'm at 60/30/10 U.S./International/REIT for my equity allocation*. This is Rick Ferri's Core-4 (the older simpler version) and for me it represents an easy-to-remember, comfortable AA with some logic behind it.

So 60/40 equity/FI becomes 36 U.S. / 18 Int. / 6 REIT / 40 FI.


*Side Note: REITs are something like 3% of the U.S. stock market but Real Estate as a whole is worth way more than that with most of it being private, hence the REIT tilt to partially make up for that and for some further diversification.

Interesting read... appreciate it. One of the comments that stuck out to me is how in the more recent past the US and international markets seem to be aligned. It feels that way even more today as markets seem to move somewhat in concert and feel more interconnected where as in the past they perhaps ran more independently. All that said, I am by far no expert and realize there is no one size fits all when it comes to personal AA. Reading some of the past posts on this site regarding international allocation seems to favor a majority have bought into some min allocation of say 15%+. Perhaps I will settle somewhere around there for now.

Thanks for the insight.

 

[OldShooter]

... One of the comments that stuck out to me is how in the more recent past the US and international markets seem to be aligned. It feels that way even more today as markets seem to move somewhat in concert and feel more interconnected where as in the past they perhaps ran more independently. ...

Factually true. In Olden Times, like maybe 20-30 years ago, the US and the international markets were less correlated, strengthening the argument for diversification. Now that we live in Tom Friedman's "flat world," the correlations are increasing but not to 1.0.

And where is the risk? If the correlation gets to 1.0 then there is no disadvantage to holding both US and international equities, just no diversification benefit. Anything less than 1.0 is an argument for diversification.

 

[Sunset]

I look at VTI, VXUS , and VT.
It seems that VXUS - which is total international except US, has been dismal over the past 10 years.
VTI is up about 188% and VT nearly splits the difference up 100%

So is picking VT simply an easier way rather than picking VXUS and VTI ?

Regression to the mean should result in VXUS skyrocketing, but will it take 10 or 20 more years to start ? It's really hard to buy it.

One important thing, is these foreign stocks should be bought outside tax sheltered plans so you get the foreign tax credit, otherwise some of the benefit is wasted.

 

[pb4uski]

I struggle with this too. But OTOH, looking at results for the last 21 years, there have been many years where international equities outperformed domestic equities.

That said, I'm 70% domestic/30% international. In the graphic below, portfolio 1 is 70% domestic/30% international and portfolio 2 is 100% domestic. From 1997 to 2010 the two portfolios were pretty close to each other... since 2010 100% domestic has been the clear winner.... time for reversion.

 

[OldShooter]

... So is picking VT simply an easier way rather than picking VXUS and VTI ? ...

Pretty much. It also eliminates any rebalancing between two funds as/if the US market cap share changes. That said, we are using two funds in one of our other accounts, FSKAX and VGTSX.

... Regression to the mean should result in VXUS skyrocketing, but will it take 10 or 20 more years to start ? It's really hard to buy it. ...

Yup. If you go back to the previous decade, though, the internationals were winning IIRC. Your comment implies that you are standing at the top of the slippery slope that leads one to start picking sectors. I have become convinced that attempting to pick sectors is not much different that trying to pick stocks, a proven losing strategy. So I don't worry about sector winners and losers -- hence the parentheses around my comment above.

 

[Gotadimple]

Pick a percentage. Pick an investment (or if you slice and dice - several). Don't worry about the historical results - you won't be in the market for the entire historical period.

I use 10% and ignore what part of my domestic investments are international (that part is a science experiment). That said, I have 75% of that 10% in SCHF and 25% in VWO, so a tilt towards emerging markets.

 

[Sunset]

The other issue with picking foreign stocks/investments is currency value.

I only buy currency un-hedged foreign investments, as hedging costs money. That policy has cost me dearly in the last many years as USD shot up.

Eventually the USD will probably (?) revert to less strong, which will add value to un-hedged positions.

 

[OldShooter]

The other issue with picking foreign stocks/investments is currency value.

I only buy currency un-hedged foreign investments, as hedging costs money. That policy has cost me dearly in the last many years as USD shot up.

Eventually the USD will probably (?) revert to less strong, which will add value to un-hedged positions.

Yes. All true. Currency is certainly a consideration for short term investments. Longer term, not so much. I took this online course two or three years ago: https://www.coursera.org/learn/portfolio-risk-management One lecture included discussion of currency risk in long-term investments and the punch line is that it is not a huge factor.

About 12 months ago +/- there was some weeping and wailing on this forum about the poor performance of internationals. Peeling the onion one found that many overseas markets were up (FTSE for example) but the rise was offset by the strengthening of the dollar.

So what do you believe about the long-term prospects for the dollar? I think lower. THe $ is buoyed by the fact that it is the world's reserve curency, offsetting our debt % of GDP which would otherwise send investors fleeing. Plus, everybody hates us just generally and more specifically because we can and do use our banking system to punish people we don't like. We're just lucky that there are no strong competitors. No one trusts the Chinese, self-immolation has taken the ruble out of the running, southern Europe weakens the Euro's competitiveness (see this week's The Economist) and so on. The yen? Maybe. It got some good press this week.

So for myself, I think the future performance of internationals in dollar terms will be boosted by currency changes. YMMV, however.

 

[Red Badger]

I won't offer advice, but I'll share my deep strategy.

10% of equities in Fido's total international stock index.
1. Why 10%? Greed.
2. Why 10%? Fear.

I'm also in the camp that thinks the international exposure in the total US market is part of my international exposure.

 

[OldShooter]

... 2. Why 10%? Fear. ...

Did you look at that video I linked? French recognizes this and discusses it a bit.

 

[easysurfer]

1/3 of my equities go in international because that feels right. End of story. I'm on to other things .

 

[Dtail]

I keep 20% of Stocks in Int'l in a 55/45 AA. Like many here, this has been a topic of interest of what's best. On one hand, we have the Cape 10 relevant ratios, while on the other hand is the correlation getting closer to 1.0?
Will stay at 20% for now. Besides Int'l is outperforming S&P 500 in 2019 so far. haha.

 

[Red Badger]

Did you look at that video I linked? French recognizes this and discusses it a bit.

I watched after I posted. And it's "what I don't know that I don't know."

I don't trust China on anything, including my money. India, while democratic, has a history of corruption and nefarious political behavior. Almost every South Korean president spends retirement - - - in prison. Not saying I might not increase foreign holdings someday. But, like annuities, just not now.

 

[LOL!]

I actually like to see huge differences between US and foreign equities. That way I can rebalance between them. Some of the differences result from exchange rates.

 

[ESRwannabe]

For my early retirement portfolio (non-retirement, taxable brokerage account) I am 50/50 between VHDYX and VIHAX which are Vanguard's High Div Yield index funds (us and foreign).

My withdrawal strategy will be to take the dividends only. Currently I'm getting a div yield of around 3.3% or so. My dividend income using 2018 payout data is roughly $14k per year. Div growth in 2018 was 11.95%. Principal invested is like $413k. I also have $100k in 401k/roth.

Plan is to switch to part-time work, or expat somewhere cheaper, in three years at age 45. I'll have 20 years vested in a pension for 60+. My goal is $18k a year in dividend income.

I think $1,500 a month is plenty to do like the Kaderli's and do some slow traveling until age 60 or whenever I would want to move back to the US.