No matter where you live, your love of hearth and home is likely to show up in your portfolio in a big way. Investors tend to direct as much as (if not more than) two-thirds of their money into companies based in their home countries, according to a study by the International Monetary Fund (IMF). This is known in behavioral-finance circles as home country bias.
No Place Like Home
Why do investors favor stocks from their own countries?
- Many tend to overestimate the performance of domestic companies while simultaneously underestimating the performance of foreign-based companies.
- Some are uncomfortable with the unfamiliar and prefer to direct their money to companies they know and recognize.
- Obtaining information to research foreign companies can be challenging.
- Tax laws can vary wildly from country to country.
- There may be a language barrier that makes foreign investing difficult.
- Some may overestimate the risk associated with owning foreign stocks.
With respect to the last point—it’s true that there are risks specific to investing overseas, including costly transaction fees, currency risk (losing money due to unfavorable currency exchange rates) and liquidity risk (once invested, you won’t be able to sell your holdings as quickly as you want). But spreading your money across a variety of different countries, regions and asset classes can actually reduce your overall exposure to risk.
U.S. stocks have performed well in recent years, but that doesn’t mean that they will always outperform foreign stocks. In fact, U.S. stocks actually underperform foreign stocks about 50% of the time. So a portfolio that invests only in U.S. stocks will underperform at least that often.
If your portfolio was invested in only U.S. stocks in 2017, it’s likely that you missed out on higher returns, since stocks in a number of other countries—both developed (Spain, France, Germany) and developing (China, Brazil, India)—surpassed the U.S. in terms of performance.
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The ABCs of D(eveloped), E(merging), F(rontier)
When dipping your toe into global investing, it’s important to understand the differences between developed, emerging and frontier markets.
Developed markets have a high level of economic growth and stability. These markets are typically seen as well-regulated, with high standards of living and a solid infrastructure. The United States, Canada and most of Western Europe are considered developed markets.
Emerging markets are countries that are in the process of becoming fully developed. They may have infrastructures that are not fully fleshed out, they may still experience considerable political instability and their currencies may fluctuate. Many countries in Asia (such as China, India, Malaysia and the Philippines) and Latin America (Mexico, Colombia, Brazil and Chile) are considered emerging markets.
Frontier markets are less-advanced than emerging markets, but they often grapple with the same issues: political instability, poor regulation and currency fluctuation. Argentina, Ukraine and Vietnam are examples of frontier markets.
(Why) Not in My Backyard?
Investors should consider looking abroad for two reasons.
- Emerging and frontier markets tend to offer faster growth—and potentially higher returns—than developed markets.
- Holding some foreign assets in your portfolio may help offset loss you would otherwise experience if there’s trouble on the home front. Not putting all of your eggs in one basket—in other words, diversifying your investments—can help you manage your overall investment risk.
Depending on your investment goals, spreading your investments across developed, emerging and frontier markets may make sense for you. For more help, leave a comment below or click here to send a confidential message to our experienced financial professionals.