Financial Fellow

Written by J.P. Wicklein

     Recently I received an email from Financial Fellow subscriber, Tim, looking to discuss and debate the appropriate allocation mix between domestic and foreign stocks.  Tim’s approach runs counter to conventional financial planning advice which recommends having 80% of your portfolio invested in U.S. stocks.  He believes the bulk of your portfolio, that’s allocated to stocks, should be invested internationally. 

     “I just haven’t heard enough good arguments for investing 80% of your portfolio in the U.S.  I understand the currency risks, but over long periods of time, this factor is usually mitigated.  It is more expensive to invest in foreign stocks (ETF and mutual fund expense ratios are generally higher).  Also, I am suspect of some foreign countries accounting standards, but I think this risk can also be controlled by spreading your investments across many countries.  Not too long ago it was difficult to invest in foreign countries, but now there are many vehicles - ETF’s, mutual funds, access to foreign exchanges.  The U.S. market capitalization is roughly 45% of the entire world’s market capitalization.  So, basically, financial advisors are all advising to overweight the U.S. on a market-cap basis. 

     Sure, the U.S. was one of the best countries to invest in over the past century, but we had less regulation then as we now look to be moving toward a European style economy.  We also used to be a saver nation, but now we are strapped with massive debt that can only result in higher taxes, higher inflation, and higher interest rates - all factors that are detrimental to economic growth.  We can’t possibly expect the same returns that U.S. investors received during the past century especially when there is a premium to U.S. stocks when comparing the valuations to other countries.  That said, I’m not totally out of U.S. stocks.  It’s been shown that a country with high GDP growth doesn’t necessarily result in high returns for investors and vice versa.”

     Tim brings up a couple, key points that I agree with and want to elaborate on: 

1)   Americans, as a whole, have run out of money.  The national savings rate has been at, or near, 0% for several years.  Now, we are running out of credit.  Many people have borrowed against the equity in their homes, run up their credit card balances, and are living above their means.  At this rate, a time will come when a large number of Americans can no longer afford to buy many of the goods and services offered by U.S. companies.  Thereby negatively impacting the value of U.S. companies and the returns of those that invest in them.

2)   The best periods of growth for the U.S. are in the rearview mirror.  Emerging markets such as Eastern Europe, parts of Asia, and Latin America offer the greatest opportunity for growth and investor returns.    

     Further, I think the American empire is on the decline.  The decline in our empire will, among other things, erode the value of our currency – the Dollar.  I believe the Dollar has already begun a long, slow decline.  As the Dollar drops in value against foreign currencies, the value of an investment in dollar-denominated U.S. companies will decline against foreign companies based in a foreign currency.  That could contribute to better returns for long term investors of foreign stocks.

     Tim’s opinion, and my thoughts, aside I still find it hard to buck conventional wisdom by shifting the bulk of my portfolio to international stocks.  (My stock allocation within retirement accounts is presently 30% international and 70% U.S.)  Perhaps I lack the conviction to act on my opinion.  Or, maybe I’m more inclined to trust the “experts” that advocate investing the bulk of your portfolio domestically.  It’s probably a bit of both.

     What do you think?  What’s the appropriate allocation percentage?  Do Tim and I have a pretty good read on the issue or are we out of our minds?  Add your comments below!

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