Increase Your Portfolio’s Return By Dropping International Funds
Summary International stocks have underperformed historically – performing even worse in the recent past. Multiple hypothetical portfolios demonstrate the poor returns of international stocks. Short periods of outperformance by international stocks do not make up for their overall performance. Will International Stocks Really Outperform? With emerging markets in the dumps and international funds trailing the returns of domestic funds, analysts everywhere are calling for investment in international stocks, claiming that the chronic underperformance is a sign that they are “due” to outperform. International stocks may very well outperform in the next few years. There is nobody who can know that for sure. I am here to present the facts, and the facts show that international stocks have not been delivering on the promise of outperformance given their higher risk. An investment portfolio built entirely from U.S. stocks can outperform international portfolios while avoiding the political and currency risks of other smaller countries. Hypothetical Portfolios For the sake of this hypothetical situation, let us assume that the owner of this portfolio will be investing in 100% equities and plans to maintain that portfolio for the next decade before moving into some safer bonds. The owner of this portfolio currently has $300,000 invested. Let us see how this portfolio would have performed from 2005 to 2015. First, a control sample: 100% U.S. equities for the entire investment period, invested in the broadest manner possible with the Vanguard Total Stock Market ETF (NYSEARCA: VTI ). In this case, the portfolio would be worth $654,240 at the end of the investment period. Not too shabby, the portfolio has more than doubled with an annualized rate of 8.12% ( Source ). Let’s say the investor wished to broadly diversify his equity portfolio with companies from around the world, putting the U.S. weighting at around 40% with the Vanguard Global Equity Fund (MUTF: VHGEX ). In this case, the portfolio would be worth $533,880 at the end of the investment period. The portfolio has increased at an annualized rate of 5.93%. The investor has missed out on $120,360 ( Source ). Perhaps the investor believed that emerging markets would be a good addition to his U.S. equities. Let’s say the investor allocated 20% to emerging markets with the Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ) and 80% to Vanguard Total Stock Market ETF. In this case, the portfolio would be worth $625,080 at the end of the investment period. The portfolio has increased at an annualized rate of just over 7.542%. The investor has missed out on $29,160 ( Source ). Let me note that emerging markets are the only international option I would consider. Emerging markets have outperformed U.S. markets from time to time and their current weakness has much to do with the strong U.S. dollar and oil prices. However, emerging markets do not represent all international stocks and therefore I still stand by the statement that international stocks, as a whole, underperform – as seen by the performance of broad international funds such as VHGEX. In all hypothetical portfolios, the investor would have been better off simply investing in the United States market and would have even paid lower fees (and perhaps taxes as well) while doing so. The below table and graph illustrate the results of including international stocks in your portfolio. (click to enlarge) (Excel, using data from Vanguard.com) (click to enlarge) (Excel, using data from Vanguard.com) International Stocks have Underperformed Historically U.S. funds have beaten international funds the past five, 10, 15, 20 and 25 years. Over the past 25 years, large-cap U.S. funds have gained an average 691%, vs. 338% for international funds. The graph below illustrates the difference in performance. (Please note I am not in favor of investments in managed futures. Managed future data is subject to extreme survivorship bias and the results are thus skewed. Survivorship bias is the logical error of concentrating on the people or things that “survived.” inadvertently overlooking those that did not because of their lack of visibility.) (click to enlarge) (AutumnGold) Small Bursts of Outperformance by International Stocks Don’t Make Them a Good Investment Some will argue that there are periods of time when international stocks outperform. This is true. However, these periods of time are often small and they haven’t made up for the underperformance both historically and lately, assuming investors invest gradually over time. For long term investors, a long history of strong performance is needed before an investment can be made. The United States stock market has provided that performance for over a century now. The below chart shows the periods of outperformance for domestic and international equities for roughly the past 20 years. As you can see, in the mid-80s international stocks did very well and mildly outperformed in the mid-2000s. However, in all other years the U.S. stock market outperformed and overall U.S. stocks came out far ahead as mentioned earlier, assuming you didn’t throw all your money into international stocks in 1984. However, most people invest over time and if you had done that, you would have had higher returns with domestic stocks. (Bason Asset Management) For the past 15 years domestic stocks have pulled ahead of international stocks by a fairly wide margin. This is achieved even when the domestic market returns are relatively normal compared to historical averages. International stocks have simply underperformed consistently. You would be very hard pressed to find an international broad market fund that has beaten a U.S. broad fund from inception to date with reasonable fees, assuming the inception dates are relatively similar and that the funds didn’t start around 1984. The Vanguard International Explorer Fund is one exception I have found as it has performed very well since inception in 1996. Unfortunately, over the past 10 years it has returned less than 6% annually. Having a Portfolio of Pure U.S. Stocks Outperforms and Provides International Exposure Investing in U.S. stocks doesn’t mean you lose out on foreign growth potential. In fact, U.S. companies are very savvy and have the luxury of being able to choose which countries to do business in. There is no reason the U.S. equity market can’t benefit from the growth of other nations. Companies in the S&P 500 get 46.2% of their earnings from overseas . If you are looking for diversification to reduce the risk of a drastic drop in your portfolio value, international stocks won’t help you. The 2008 stock market crash showed that all equities fell drastically at the same time. Investing in one country or another made no difference. So do the smart thing: invest in domestic funds and enjoy the decent returns, as boring as they may be.