Arlington Chamber of Commerce Blog

 

Home-Country Bias in Investing

by Admin 8. April 2015 06:24

by Marcio Silveira, CFP, CFA, CAIA, Pavlov Financial Planning 

Do you invest too much where you live?

If you are like most people, your answer is “yes”.  The majority of investors act this way because familiarity builds confidence. The problem is that this confidence does not really mean knowledge and expertise. Investing too much where you live can mean missed opportunities and taking too many risks. The technical term for this behavior is the home-country bias.

U.S. and International

For U.S. based investors this tendency is not a very serious problem. This is simply because the United States has a large share of global investable stocks and represents roughly 40% of the global stock market.

Being based here in the United States allows us to invest in any part of the world in a very cost effective way, but we generally miss this opportunity because our home-country bias is skewing our investment decision-making. We typically have over 80% of our stock portfolios based in the U.S.  Burton Malkiel, a professor at Princeton University, discussed the home-country bias in this interview. 

This tendency is much more serious in smaller countries, however. Investors based in Canada, for example, hold the majority of their stocks in Canada, but their market is less than 5% of the global market. These investors will also have a disproportionate exposure to some specific industries that are prominent in each market. In the case of Canada, there will to a very large exposure to commodities in general and mining in particular. It is certainly too much risk that is easily avoidable.

Immigrants and Expats

The problem persists when investors move. Immigrants in the United States keep investing too much in their countries of origin. There is a false illusion that they know what is really going on. The reality is that most immigrants know very little about the drivers of stock market performance in their countries of origin, and they invest there simply because of familiarity and the confidence associated with it.

U.S. Expats in other countries also tend to have too much of their investments in the United States, but they also invest in their new countries of residence. The result of neglecting other countries is an investment portfolio that can miss opportunities for better returns in relation to the risk taken and, in some cases, reckless risk exposures.

Owning the World

The most sensible approach to benefit the most from diversification (which reduces the risk while keeping the expected return) is to have a globally diversified portfolio. This is accomplished very easily by a U.S. based investor with very simple portfolios of less than 5 Exchange Traded Funds – ETFs. In the extreme, this global diversification can be accomplished with just one security. An interesting example is the Vanguard Total World Stock ETF (ticker: VT) 

Having a true global exposure allows investors to keep the course of consistent investment with controlled risk because of the very broad exposure.

Recent Performance and Opportunity for Non-U.S. Investments

In the past 3 years, U.S. Stocks have performed significantly better than International Stocks (including Developed and Emerging). This means that the relative stronger performance further increases the weight of the US in the global stock market. For example, the Vanguard Total Stock Market ETF (U.S. Stocks) has returned 20.5% over the past 3 years and the Vanguard Total International Stock ETF (International Stocks) has returned 8.94%.

The conclusion is that investing internationally in a meaningful way is always sensible, and right now there seems to be a particularly good opportunity to do so.

 

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