A recent Morningstar article reports that most U.S. investors have a home bias and suggests that “foreign stocks should represent a considerable portion of most investors’ portfolios.”
“Home bias isn’t unique to U.S. investors,” the article says, “and it’s understandable. Domestic stocks tend to have less currency risk than foreign stocks, which tends to make them slightly less volatile and more appealing, as most investors’ expenditures are predominately in their home currency.” It argues, however, that such a bias can harm diversification and is usually based misconceptions, including the following:
- There is enough diversification in U.S. stocks: The fact that large U.S companies do business all over the world “may create the impression that U.S. stocks offer sufficient global diversification and that it isn’t necessary to invest in foreign-listed stocks. But that’s misleading.”
- The U.S. is a good place to do business, which should lead to strong market performance: While the article emphasizes that “the U.S. has a lot going for it,” it points out that this isn’t news, and is already baked into share prices.
- The U.S. market will outperform foreign stock markets: Just because the U.S. has been among the best-performing markets across the globe in recent decades doesn’t mean it will continue to be in the future.
The article reports that the correlation between U.S. and foreign stocks has fallen in recent years, “suggesting that the diversification benefits of owning foreign stocks have improved,” and that adding foreign stocks to a “U.S.-centric portfolio shouldn’t significantly increase portfolio volatility, despite their higher stand-alone volatility.”
Regarding what is the right amount of allocation for foreign stocks, the article says about 47%, “if the goal is to take full advantage of their diversification potential, and the correlations and volatility of U.S. and foreign stocks from January 2000 to June 2019 are representative of the future.” It adds, however, that a 33% allocation over the same period would have achieved 92% of the “maximum diversification benefit.”