Domestic / I'ntl Stock Indexing Ratio?

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Domestic / I'ntl Stock Indexing Ratio?

Postby bobsmith » Fri Apr 05, 2013 11:22 am

The Vanguard planner I spoke to suggested I allocate to a 70%/30% US Stock/International Stock ratio (using their TSMI and TInternationalSMI) I know this ratio is adjusted for risk tolerance, but is there an ideal ratio strictly in terms of best diversification? If you're trying to index the global economy, shouldn't the-rest-of-the-world get more than 30% representation? And, so far as I understand, why doesn't Vanguard advocate diversifying bonds in non-domestic markets? Isn't the whole point of indexing to try to best represent the market itself, the use the stock/bond ratio to adjust your risk level?
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Re: Domestic / I'ntl Stock Indexing Ratio?

Postby Random Musings » Fri Apr 05, 2013 11:38 am

bobsmith wrote:The Vanguard planner I spoke to suggested I allocate to a 70%/30% US Stock/International Stock ratio (using their TSMI and TInternationalSMI) I know this ratio is adjusted for risk tolerance, but is there an ideal ratio strictly in terms of best diversification? If you're trying to index the global economy, shouldn't the-rest-of-the-world get more than 30% representation? And, so far as I understand, why doesn't Vanguard advocate diversifying bonds in non-domestic markets? Isn't the whole point of indexing to try to best represent the market itself, the use the stock/bond ratio to adjust your risk level?


Vanguard will advocate diversifying international bonds, once their international bond fund is available. They will place that component inside their Target Retirement Funds (I think 80/20). Also, once that fund is available, it will be interesting to see if that becomes part of their "core" recommendation for people who solicit for their portfolio advice. To be consistent, they probably will do that.

On the equity side, with the 70/30 recommendation, that parallels their current allocation in equities in their TR funds. Not too long ago, they recommended 80/20. On this board (looking at this from a U.S. investors standpoint), you still have some who are 100% domestic only and others who go to the (roughly) 40 US/60 Int'l which is to replicate how the world looks today. Perhaps others, with valuations looking more attractive for int'l equities, are loading up even a little more. Larry has mentioned that what is "best" is to start with the "world" look and adjust from there. OTOH, Vanguard published a paper in the past few years where is looked like the sweet spot was in the 30-45% range (off the top of my head). Around 2000, I was around 30% international, today I'm around 43% international.

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Re: Domestic / I'ntl Stock Indexing Ratio?

Postby CyberBob » Fri Apr 05, 2013 11:50 am

Check out the Vanguard paper Considerations for investing in non-U.S. equities (PDF).

Executive summary. Non-U.S. equities currently account for close to 55% of global market capitalization, thus representing a significant opportunity for U.S. investors. In addition, the portfolio of an investor who combined non-U.S. equities with U.S. equities over the past several decades would have experienced lower average volatility—despite similar realized returns and volatilities in each region. U.S. investors who recognize this opportunity for diversification are increasingly investing abroad.

According to data from the Investment Company Institute (2011), international equity funds constitute 27% of the total equity allocation of U.S. mutual fund investors. This paper weighs the short- and long-term impacts on a portfolio of currency fluctuations, correlations, cost, and expected risks and returns, and concludes that:

• Non-U.S. equities should be considered for inclusion in a domestic portfolio.
• Although there is no right answer for all investors, empirical and practical considerations suggest a reasonable starting allocation to non-U.S. stocks of 20%, with an upper limit based on global market capitalization.
• The exact allocation to non-U.S. equities will depend on the investor’s view regarding the short- and long-term trade-offs.

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Re: Domestic / I'ntl Stock Indexing Ratio?

Postby Rick Ferri » Fri Apr 05, 2013 12:37 pm

• The exact allocation to non-U.S. equities will depend on the investor’s view regarding the short- and long-term trade-offs


The exact allocation can only be known in retrospect and it will depend almost entirely on dollar strength or weakness relative to other currencies. Solve the currency puzzle and you'll have the answer. In the mean time, 30% international is reasonable since we pay our bills in US dollars.

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Re: Domestic / I'ntl Stock Indexing Ratio?

Postby G-Money » Fri Apr 05, 2013 1:22 pm

Rick Ferri wrote:
• The exact allocation to non-U.S. equities will depend on the investor’s view regarding the short- and long-term trade-offs


The exact allocation can only be known in retrospect and it will depend almost entirely on dollar strength or weakness relative to other currencies. Solve the currency puzzle and you'll have the answer.

While that is technically true, can't we come pretty close? For example, the iShares MSCI ACWI Index ETF (ACWI) tracks the global market (though only large caps, I believe). Per iShares's website, as of yesterday, 46.81% was invested in US companies. The remainder, by extension, is in ex-US companies. So you would come pretty close to accurately tracking the global market by putting 46.81% in a domestic stock fund and 53.19% in a foreign stock fund. If you wanted to be even more precise, you could track today's movement in the domestic and international markets, and adjust your allocation to each according to whether one increased or decreased more than the other. Perhaps you wouldn't be accurate to 4 significant digits, but I think most would agree you'd be close enough. Thereafter, your funds would then move in direct proportion with the markets and currencies, maintaining their global weight. Just like investors who hold S&P 500 and the Extended Market Index to approximate TSM.

Or, if you don't mind paying a slightly higher ER, you could just hold VT (ER = .19%) or ACWI (ER = .34%). No guesswork required.
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Re: Domestic / I'ntl Stock Indexing Ratio?

Postby Rick Ferri » Fri Apr 05, 2013 1:51 pm

The remainder, by extension, is in ex-US companies. So you would come pretty close to accurately tracking the global market by putting 46.81% in a domestic stock fund and 53.19% in a foreign stock fund.


The Vanguard Total World Stock ETF (VT) does it all for you. Or you coud do 50% VTI and 50% VEU at about 0.1%. The question asked was how much should a person put in international. The answer is personal. I suggest 30%. Having a market cap weight is fine also. It's all based on what you're trying to do.

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Re: Domestic / I'ntl Stock Indexing Ratio?

Postby G-Money » Fri Apr 05, 2013 1:57 pm

Rick Ferri wrote:
The remainder, by extension, is in ex-US companies. So you would come pretty close to accurately tracking the global market by putting 46.81% in a domestic stock fund and 53.19% in a foreign stock fund.


The Vanguard Total World Stock ETF (VT) does it all for you. Or you coud do 50% VTI and 50% VEU at about 0.1%. The question asked was how much should a person put in international. The answer is personal. I suggest 30%. Having a market cap weight is fine also. It's all based on what you're trying to do.

Rick Ferri

Right, see the last line in my post above re VT or ACWI.

To be clear, I was simply addressing the point that one *could* accurately track global weights, with either one or multiple funds. Certainly not addressing what one *should* do. That topic has been discussed ad nauseam in other threads. :)
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