30% In International Stocks?

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Humdrum
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30% In International Stocks?

Post by Humdrum » Wed Nov 12, 2014 3:42 pm

Is 30% in International stocks too much? I approximated the 3-fund portfolio with the funds below (minus the TIPS fund) and back tested it up against the actual 3-fund portfolio via Portfolio Visualizer over the last 15 years & I came within less than 1% of the value of it. I did the 3-fund via a 60/40 AA (40/20/40). Yet I am wondering if I should move from 40% in U.S. Stocks down to 30% and up my International stock from 20% to 30% so it would be a 60/40 AA (30/30/40). Or am I better off just staying the course? Any suggestions?


U.S. Stocks
30% Vanguard Institutional Index Fund Institutional Plus Shares .02% fee
4% Vanguard Mid-Cap Index Fund Institutional Plus Shares .06% fee
6% Vanguard Small-Cap Index Fund Institutional Plus Shares .06% fee

International Stocks
20% SSgA Global Equity ex U.S. Index Non-Lending Series Fund Class C .17% fee
(Tracks: MSCI ACWI ex-USA Index)

Bond Index
35% SSgA U.S. Bond Index Non-Lending Series Fund Class C .06% fee
(Tracks: Barclays Capital U.S. Aggregate Index)
5% (TIPS) Northern Trust Treasury Inflation-Protected Securities Index Fund - Non Lending .08% fee
(Tracks: Barclays Capital U.S. Treasury Inflation Protected Securities (TIPS) Index.)

John3754
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Re: 30% In International Stocks?

Post by John3754 » Wed Nov 12, 2014 3:49 pm

There's no correct answer to this question, opinions vary, but 30% is perfectly reasonable in my opinion. Jack Bogle recommends 0-20%, Vanguard recommend 20-40%, many recommend up to the market cap weight which is 50%, I myself currently have 40%. Nobody can tell the future so nobody knows which allocation will do best going forward.

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Re: 30% In International Stocks?

Post by abuss368 » Wed Nov 12, 2014 3:52 pm

30% or 40% of equity allocation to International stocks is probably not going to make much difference. Vanguard allocates 30% of equity in both the Life Strategy and Target funds. This was increased from 20% of equity a few years ago.

It is more important to not worry about back testing or other rear view mirror analysis. In fact regulations require a statement that past performance is not guarantee of future returns.

As a Boglehead, once you decide on a strategy, your goal should be to "stay the course".

Best.
John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + U.S. & International REITs

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Re: 30% In International Stocks?

Post by nisiprius » Wed Nov 12, 2014 3:56 pm

Careful, everybody. "30% in international" often means 30% of the stocks in the portfolio are international. This is not what humdrum seems to mean.

humdrum is talking about being at "40/20/40" and "moving from 40% in U.S. Stocks down to 30% and up my International stock from 20% to 30% so it would be a 60/40 AA (30/30/40)."

In terms of percentages of U.S. and international within the stock allocation, humdrum has 1/3 or 33% of his or her stocks invested internationally, and is considering going to 50/50 (equal amounts of U.S. and international, each 30% of the total portfolio).

Vanguard's all-in-one funds have about 30% of their stocks in international.

The highest international allocation seems to be 26.31%, in Target Retirement 2055, 62.55% U.S. 26.31% international = 29.6% of the stocks are international.
The lowest seems to be Vanguard LifeStrategy Income: 13.81% U.S., 5.72% international = 29.3% of the stocks are international.

humdrum, I would say this much. Having equal quantities invested in U.S. and international is probably fine but you want to have a clearly articulated reason why you want to have that much international, because it is at the high end of Vanguard's suggestions, higher than Vanguard uses in their all-in-one funds, and higher than many Bogleheads hold.
Last edited by nisiprius on Wed Nov 12, 2014 4:08 pm, edited 4 times in total.
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G-Money
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Re: 30% In International Stocks?

Post by G-Money » Wed Nov 12, 2014 3:59 pm

The median Boglehead that responds to these polls has right around 30% of equity (not portfolio) in international:
http://www.bogleheads.org/forum/viewtop ... &p=1783030 (Aug 2013)
http://www.bogleheads.org/forum/viewtop ... 0&t=103617 (Oct 2012)
http://www.bogleheads.org/forum/viewtop ... =1&t=91132 (Feb 2012)
http://www.bogleheads.org/forum/viewtopic.php?t=70974 (Apr 2011)

I'm sure I've missed a few, but you get the idea.
Don't assume I know what I'm talking about.

Humdrum
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Re: 30% In International Stocks?

Post by Humdrum » Wed Nov 12, 2014 4:01 pm

I wholeheartedly agree that "past performance is not a guarantee of future returns". As it is, U.S. stocks are currently going through the roof whereas International stocks aren't doing so well. This coupled with the fact that in the next decade International stocks are projected to be doing very well. So I am just wondering if a 50/50 split between International/U.S. in the equity part of an AA would provide a good balance?

kenner
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Re: 30% In International Stocks?

Post by kenner » Wed Nov 12, 2014 4:10 pm

Humdrum wrote:I wholeheartedly agree that "past performance is not a guarantee of future returns". As it is, U.S. stocks are currently going through the roof whereas International stocks aren't doing so well. This coupled with the fact that in the next decade International stocks are projected to be doing very well. So I am just wondering if a 50/50 split between International/U.S. in the equity part of an AA would provide a good balance?
One way to look at this: Millions of investors world-wide have already determined that US and International equities warrant a roughly 50/50 split. Given the perceived advantages of index/market weight investing, why would an individual investor want to deviate from global weightings?

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Re: 30% In International Stocks?

Post by midareff » Wed Nov 12, 2014 4:10 pm

Humdrum wrote:I wholeheartedly agree that "past performance is not a guarantee of future returns". As it is, U.S. stocks are currently going through the roof whereas International stocks aren't doing so well. This coupled with the fact that in the next decade International stocks are projected to be doing very well. So I am just wondering if a 50/50 split between International/U.S. in the equity part of an AA would provide a good balance?
Unfortunately that's a crystal ball question all of us wish we knew the answer too.

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Re: 30% In International Stocks?

Post by retiredjg » Wed Nov 12, 2014 4:14 pm

Humdrum wrote:Is 30% in International stocks too much? I approximated the 3-fund portfolio with the funds below (minus the TIPS fund) and back tested it up against the actual 3-fund portfolio via Portfolio Visualizer over the last 15 years & I came within less than 1% of the value of it. I did the 3-fund via a 60/40 AA (40/20/40). Yet I am wondering if I should move from 40% in U.S. Stocks down to 30% and up my International stock from 20% to 30% so it would be a 60/40 AA (30/30/40). Or am I better off just staying the course? Any suggestions?
I think you should look at it differently. You are talking about a percentage of your portfolio. That is a fixed number. What you should be considering is a certain percentage of your stocks and then let that determine the percentage in your portfolio. In that way your US to international ratio will stay the same as you change your stock to bond ratio.

For example, 30% of a 60/40 portfolio would be 42 US/18 International/40 Bonds (because 18 is 30% of 60). What you currently have is 33% of your stocks in international (40/20/30). If you use 30/30/40 you actually have half of your stocks in international. That is a somewhat different profile than having about 1/3rd of your stocks in international. This is why it is best to decide what part of your stocks you want in international rather than what part of your portfolio you want in international.


Your question is whether to change from 1/3 to 1/2 of your stocks in international. Only you can answer that. You should know that your risk will increase some (foreign stocks are riskier than US stocks) and your costs may increase a little. Vanguard suggests using between 20% and 40% of your stocks in international. They say the benefit drops off after about 40% (among other things, the international fund costs more). However they do acknowledge that some people want to hold something like the actual market weight. Last I checked, it was about half US and half foreign. I've seen it as high as 58% foreign.

I've seen some portfolios where all the international needs to be held in Roth IRA because of the cost of the international funds in the 401k. For these people, maintaining half their stocks in international can be tough because of the limited amount of money that can go to Roth IRA each year.

Just putting everything together - the cost of your international fund, how easy it is to get money into it, the risk of having half your stock there instead of about a third....what international allocation do you want? Unless you have a strong desire to go half and half, I think about a third is a good middle of the road place to be.

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Re: 30% In International Stocks?

Post by Chan_va » Wed Nov 12, 2014 4:17 pm

Humdrum wrote:I wholeheartedly agree that "past performance is not a guarantee of future returns". As it is, U.S. stocks are currently going through the roof whereas International stocks aren't doing so well. This coupled with the fact that in the next decade International stocks are projected to be doing very well. So I am just wondering if a 50/50 split between International/U.S. in the equity part of an AA would provide a good balance?
Humdrum, there are 2 generally accepted axioms of investing.

1. Momentum - in the short term, things that are going up tend to keep going up
2. Mean reversion - in the long term, things will revert back to their mean

Sounds easy right? The catch is this - No one knows what "short term" or "long term" mean. Or even if they have a meaning in the markets. Things could go up for 6 months, then mean revert, or 2 decades, then mean revert. You have no way of knowing.

So, just pick an allocation and stick to it.

retiredjg
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Re: 30% In International Stocks?

Post by retiredjg » Wed Nov 12, 2014 4:32 pm

Humdrum wrote: This coupled with the fact that in the next decade International stocks are projected to be doing very well.
Really? Well, I'm sure somebody has this opinion, but it is nothing other than opinion. Nobody knows how well international stocks will do in the next decade. Anybody who makes a projection is just guessing based on things they believe to be true. But reality can turn out much differently.

This is called "noise". Ignore it. :D

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Re: 30% In International Stocks?

Post by abuss368 » Wed Nov 12, 2014 5:11 pm

kenner wrote:
Humdrum wrote:I wholeheartedly agree that "past performance is not a guarantee of future returns". As it is, U.S. stocks are currently going through the roof whereas International stocks aren't doing so well. This coupled with the fact that in the next decade International stocks are projected to be doing very well. So I am just wondering if a 50/50 split between International/U.S. in the equity part of an AA would provide a good balance?
One way to look at this: Millions of investors world-wide have already determined that US and International equities warrant a roughly 50/50 split. Given the perceived advantages of index/market weight investing, why would an individual investor want to deviate from global weightings?
I have been thinking about this for a while. In addition, would it not be a simple Boglehead way to just split US and International in half?
John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + U.S. & International REITs

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Re: 30% In International Stocks?

Post by livesoft » Wed Nov 12, 2014 5:15 pm

I was 31% of portfolio in international stocks for quite a while, but decided that 29% was better. Read this thread: http://www.bogleheads.org/forum/viewtop ... 1&t=150267
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kenner
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Re: 30% In International Stocks?

Post by kenner » Wed Nov 12, 2014 5:22 pm

Abuss368;

I don't pretend to know what the future holds, but it seems that if we trust investors to determine the market value for US equities (i. e., endorsing index investing), we should at least be willing to ask "do we trust investors to determine the market value for international equities"?

Then again, maybe it's easier to outsmart international investors.

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Re: 30% In International Stocks?

Post by retiredjg » Wed Nov 12, 2014 5:30 pm

kenner wrote:One way to look at this: Millions of investors world-wide have already determined that US and International equities warrant a roughly 50/50 split. Given the perceived advantages of index/market weight investing, why would an individual investor want to deviate from global weightings?
All things being equal, that is a good argument.

But International stocks cost more, there is more risk involved, and if the foreign stocks are in a tax-advantaged account, there is a bit of double taxation. So I don't see all things being equal. Not saying that others should avoid it, I just don't choose half and half myself. The argument for market weights does not make sense to me in this situation.

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Re: 30% In International Stocks?

Post by kenner » Wed Nov 12, 2014 5:41 pm

retiredjg wrote:
kenner wrote:One way to look at this: Millions of investors world-wide have already determined that US and International equities warrant a roughly 50/50 split. Given the perceived advantages of index/market weight investing, why would an individual investor want to deviate from global weightings?
All things being equal, that is a good argument.

But International stocks cost more, there is more risk involved, and if the foreign stocks are in a tax-advantaged account, there is a bit of double taxation. So I don't see all things being equal. Not saying that others should avoid it, I just don't choose half and half myself. The argument for market weights does not make sense to me in this situation.
So you are willing to trade world-wide risk for one-country risk (US), even though the world has bounced back from WWII devastation and some people are decrying long-term US economic, military and financial viability. No real argument here since the detractors are hopefully wrong.

In any event, each investor should determine their own comfort level. To me, anything from 20% to 50% equities in international is acceptable.

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Re: 30% In International Stocks?

Post by retiredjg » Wed Nov 12, 2014 8:42 pm

kenner wrote:In any event, each investor should determine their own comfort level. To me, anything from 20% to 50% equities in international is acceptable.
I agree that anything from 20% to 50% of stocks is reasonable. This assumes the investor wants to hold foreign stocks at all. Apparently, some don't.

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Re: 30% In International Stocks?

Post by rob » Wed Nov 12, 2014 8:54 pm

retiredjg wrote:But International stocks cost more, there is more risk involved, and if the foreign stocks are in a tax-advantaged account, there is a bit of double taxation.
I see this repeated a lot and while I agree on higher costs and potentially extra tax for US based investors, I am lost why non-US stocks are more "risky" as a general statement.

For example, a small cap US stock will and should be "risker" by most peoples definitions compared to a large cap stock in a developed country (currency aside). I think it adds noise to the conversation by over-generalising.
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Re: 30% In International Stocks?

Post by asset_chaos » Wed Nov 12, 2014 9:21 pm

Humdrum wrote:Is 30% in International stocks too much?
Really, the question is, is it too much for you? If that's your plan and you can stick with it and rebalance to it no matter how well or poorly foreign does in relation to domestic, then it's the right amount for you. If you're worried that you won't be able to stick with your plan, then definitely revise your plan to one you can stick with no matter what.
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Re: 30% In International Stocks?

Post by nisiprius » Wed Nov 12, 2014 10:15 pm

rob wrote:
retiredjg wrote:But International stocks cost more, there is more risk involved, and if the foreign stocks are in a tax-advantaged account, there is a bit of double taxation.
I see this repeated a lot and while I agree on higher costs and potentially extra tax for US based investors, I am lost why non-US stocks are more "risky" as a general statement. For example, a small cap US stock will and should be "risker" by most peoples definitions compared to a large cap stock in a developed country (currency aside). I think it adds noise to the conversation by over-generalising.
1) Vanguard's broad-brush "risk potential" categories put Total International Stock Index Fund (VGTSX) at risk level 5, Total [U.S.] Stock Market Index Fund (VTSMX) at risk level 4.

2) Morningstar is showing the 15-year standard deviation, a measure of volatility, as 18.45 for VGTSX, 15.83 for VTSMX. Not a large difference, but nevertheless, VGTSX has been more volatile.

3) In the summary prospectus for VGTSX, Vanguard gives these reasons why they consider non-U.S. stocks to be more risky than U.S. stocks as a general statement. Vanguard says this:
Primary Risks
An investment in the Fund could lose money over short or even long periods. You should expect the Fund’s share price and total return to fluctuate within a wide range, like the fluctuations of global stock markets. The Fund is subject to the following risks, which could affect the Fund’s performance:
• Stock market risk, which is the chance that stock prices overall will decline. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. The Fund’s investments in foreign stocks can be riskier than U.S. stock investments. The prices of foreign stocks and the prices of U.S. stocks have, at times, moved in opposite directions. In addition, the Fund’s target index may, at times, become focused in stocks of a particular market sector, which would subject the Fund to proportionately higher exposure to the risks of that sector.
• Investment style risk, which is the chance that returns from non-U.S. small- and mid-capitalization stocks will trail returns from global stock markets. Historically, non- U.S. small- and mid-cap stocks have been more volatile in price than the large-cap stocks that dominate the global markets, and they often perform quite differently.
• Country/regional risk, which is the chance that world events—such as political upheaval, financial troubles, or natural disasters—will adversely affect the value of securities issued by companies in foreign countries or regions. Because the Fund may invest a large portion of its assets in securities of companies located in any one country or region, the Fund’s performance may be hurt disproportionately by the poor performance of its investments in that area. Country/regional risk is especially high in emerging markets.
• Currency risk,which is the chance that the value of a foreign investment, measuredin U.S. dollars, will decrease because of unfavorable changes in currency exchange rates. Currency risk is especially high in emerging markets.
• Emerging markets risk, which is the chance that the stocks of companies located in emerging markets will be substantially more volatile, and substantially less liquid, than the stocks of companies located in more developed foreign markets because, among other factors, emerging markets can have greater custodial and operational risks; less developed legal, regulatory, and accounting systems; and greater political, social, and economic instability than developed markets.
Last edited by nisiprius on Wed Nov 12, 2014 10:23 pm, edited 4 times in total.
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Re: 30% In International Stocks?

Post by z3r0c00l » Wed Nov 12, 2014 10:18 pm

kenner wrote:
One way to look at this: Millions of investors world-wide have already determined that US and International equities warrant a roughly 50/50 split. Given the perceived advantages of index/market weight investing, why would an individual investor want to deviate from global weightings?
Exactly. If market cap indexing works for US stocks, why would it not be the same system for an investor globally?

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Re: 30% In International Stocks?

Post by nisiprius » Wed Nov 12, 2014 10:24 pm

z3r0c00l wrote:
kenner wrote:
One way to look at this: Millions of investors world-wide have already determined that US and International equities warrant a roughly 50/50 split. Given the perceived advantages of index/market weight investing, why would an individual investor want to deviate from global weightings?
Exactly. If market cap indexing works for US stocks, why would it not be the same system for an investor globally?
Because of currency risk, which, for a U.S. investor, exists for international stocks and not for U.S. stocks. If we had a single global currency, it would be the same, but we don't, so it isn't.

It's possible to argue about the effect and the importance of currency risk, but it's there and it means that the argument for cap-weighting domestic stocks does NOT carry over unchanged for global stocks.

Over the last six months, for example, the dollar index has increased by about 10%, and over that period of time VGTSX has fallen about 10% behind VTSMX. In short, the recent underperformance of VGTSX is just about explained by currency risk, specifically the strengthening dollar.
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Re: 30% In International Stocks?

Post by InertiaMan » Thu Nov 13, 2014 1:48 am

Humdrum,

IMHO, both your current US:ex-US equity proportion (67:33) and the target proportion you're considering (50:50) are within the range of "reasonable," though 50/50 is probably the edge of the reasonable spectrum. Few bogleheads would call you crazy for either choice, despite the fact that we will all happily debate "which is better?"

It sounds like your base motivation is the presumption that expected returns are higher for ex-US over some future time horizon. Others here have observed that there is no real "proof" of that and the market has already priced in the probabilistic outcome. Still, there is reasonable evidence to support that position (ex-US valuations currently lower on absolute and relative basis, folks like Bernstein publishing higher expected returns for ex-US, etc). So while such a bet could very well prove wrong, the ex ante rationale for making the bet isn't unreasonable. As Bernstein has said, valuations do matter. If one is trying to decide among a range of allocation for a risky asset, It is completely reasonable, arguably wise, to skew toward the lower end of the range if the current valuation of that asset is high, and inversely to skew toward the higher end of that range if the valuation is low.

Finding your own decision might be influenced by other factors which your OP doesn't provide. For example:
How are your holdings spread across taxable and tax-protected?
If you move from 67/33 to 50/50, would you do so by using new money? Or by selling US?
If selling US, is it currently carrying large cap gains?
How many years have you been in 67:33?
Different answers to these questions could bias your decision.

If you are still in accumulation phase, and your periodic contributions are a meaningful % of total portfolio, then one "compromise" approach you can consider is to simply direct all new money at ex-US with the goal of moving your 67:33 to 60:40 over time. Others will criticize this as "not staying the course" with your original allocation, but less dogmatic folks would find this acceptable if done in a structured manner, with a solid rationale and not simply out of whimsy.

I support nispirius' comment above (paraphrasing) that, if you do this, you should have a very clear rationale on why, and furthermore you should feel comfortable committing to it longterm.

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Re: 30% In International Stocks?

Post by Valuethinker » Thu Nov 13, 2014 5:15 am

kenner wrote:
retiredjg wrote:
kenner wrote:One way to look at this: Millions of investors world-wide have already determined that US and International equities warrant a roughly 50/50 split. Given the perceived advantages of index/market weight investing, why would an individual investor want to deviate from global weightings?
All things being equal, that is a good argument.

But International stocks cost more, there is more risk involved, and if the foreign stocks are in a tax-advantaged account, there is a bit of double taxation. So I don't see all things being equal. Not saying that others should avoid it, I just don't choose half and half myself. The argument for market weights does not make sense to me in this situation.
So you are willing to trade world-wide risk for one-country risk (US), even though the world has bounced back from WWII devastation and some people are decrying long-term US economic, military and financial viability. No real argument here since the detractors are hopefully wrong.
Actually that's not really the argument made.

The argument is that if the US is now over 50% of world equities by market cap, it's a lot harder to grow beyond that than it would be to get to 50%. By the simple mathematics. Each time US-listed companies grow in market cap now, they, in effect, increase the pie which they are taking up-- ie they dilute themselves. This was always true but the effect is greater when they are over 50%.

Also US is say c. 20% of world GDP (22% in actuality?), but half its stock market value. At current growth rates, US share of GDP in the world will shrink (true of all developed nations). So it's a stretch to argue that it should still be 50%+ of world market cap. Other countries have stock markets.

Complicating the picture is that more multinationals list in the US than anywhere else. But whilst the US has lots of tech stocks (hence its recent performance) Alibaba is, of course, not a tech stock HQ'd in the USA. And it's unlikely the world's largest mining companies would come to list in NY, sitting comfortably in London. So there are sectoral effects.

A final argument is that the PE on the US market, relative to Japan or Europe, is at a near all time high.

None of this says the US is not viable. Britain remained viable throughout the 20th century, despite 2 bankrupting world wars and all kinds of disruption (civil war over Ireland, national strike, 20% + inflation in the 70s etc.). However our stock market is no longer the world's largest (although in fact, #2/3 after US and Japan). Conversely Japan is the world's 3rd-4th largest economy yet its stock market is (now) relatively small.

It's just that you are big, you got there first (second, after us) and the rest of the world (particularly Asia) is rising. Stock market values are likely to reflect that (with a lag).

In any event, each investor should determine their own comfort level. To me, anything from 20% to 50% equities in international is acceptable.
If we really believed the US wasn't viable we'd have massive underweightings. That's a lot of risk for US based investors. People here seem comfortable with a range up to the market cap weighting (a bit under 50% for non US developed markets).

Emerging Markets is a harder call because of all the structural and governance issues in their markets. When you buy a Chinese stock, you are often a minority shareholder with some branch of the Chinese government.

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Re: 30% In International Stocks?

Post by Valuethinker » Thu Nov 13, 2014 5:19 am

Humdrum wrote:Is 30% in International stocks too much? I approximated the 3-fund portfolio with the funds below (minus the TIPS fund) and back tested it up against the actual 3-fund portfolio via Portfolio Visualizer over the last 15 years & I came within less than 1% of the value of it. I did the 3-fund via a 60/40 AA (40/20/40). Yet I am wondering if I should move from 40% in U.S. Stocks down to 30% and up my International stock from 20% to 30% so it would be a 60/40 AA (30/30/40). Or am I better off just staying the course? Any suggestions?


U.S. Stocks
30% Vanguard Institutional Index Fund Institutional Plus Shares .02% fee
4% Vanguard Mid-Cap Index Fund Institutional Plus Shares .06% fee
6% Vanguard Small-Cap Index Fund Institutional Plus Shares .06% fee

International Stocks
20% SSgA Global Equity ex U.S. Index Non-Lending Series Fund Class C .17% fee
(Tracks: MSCI ACWI ex-USA Index)

Bond Index
35% SSgA U.S. Bond Index Non-Lending Series Fund Class C .06% fee
(Tracks: Barclays Capital U.S. Aggregate Index)
5% (TIPS) Northern Trust Treasury Inflation-Protected Securities Index Fund - Non Lending .08% fee
(Tracks: Barclays Capital U.S. Treasury Inflation Protected Securities (TIPS) Index.)
Either 20% or 30% allocation would work. Your final outcome isn't likely to be wildly different. Some periods, perhaps even a decade, you'd wish you had more foreign and less USA, and vice versa.

EDIT: I made a mistake. 30% of your *equity portfolio*. If it is 30% of your *total assets* then you've added volatility. Maybe for good reason, but you have added significant volatility.

I'd go for a 30% on a valuation argument (EDIT: 30% of your total assets is pushing it). By various measures, the US market looks at an all time high in expense relative to international stocks. However some of that is simply sectoral (the US has Apple, for example). And AFAIK there is not overwhelming evidence that the US is therefore likely to underperform.

Whatever the US economic problems, both Europe and Japan look worse.
Last edited by Valuethinker on Thu Nov 13, 2014 8:05 am, edited 1 time in total.

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Re: 30% In International Stocks?

Post by kenner » Thu Nov 13, 2014 7:30 am

nisiprius wrote:
z3r0c00l wrote:
kenner wrote:
One way to look at this: Millions of investors world-wide have already determined that US and International equities warrant a roughly 50/50 split. Given the perceived advantages of index/market weight investing, why would an individual investor want to deviate from global weightings?
Exactly. If market cap indexing works for US stocks, why would it not be the same system for an investor globally?
Because of currency risk, which, for a U.S. investor, exists for international stocks and not for U.S. stocks. If we had a single global currency, it would be the same, but we don't, so it isn't.

It's possible to argue about the effect and the importance of currency risk, but it's there and it means that the argument for cap-weighting domestic stocks does NOT carry over unchanged for global stocks.

Over the last six months, for example, the dollar index has increased by about 10%, and over that period of time VGTSX has fallen about 10% behind VTSMX. In short, the recent underperformance of VGTSX is just about explained by currency risk, specifically the strengthening dollar.
Is it possible that the US dollar could lose value? If it does lose value at some point (say 10%) what will happen to relative values of international stock indexes vs. US stock indexes? IIRC, some people argue that US deficit spending (and perhaps some other issues) jeopardizes the value of the US dollar.

Do we have reason to believe that investors world-wide are not aware of the existence and effect of currency value fluctuations?

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Re: 30% In International Stocks?

Post by Valuethinker » Thu Nov 13, 2014 8:03 am

kenner wrote:
Is it possible that the US dollar could lose value? If it does lose value at some point (say 10%) what will happen to relative values of international stock indexes vs. US stock indexes? IIRC, some people argue that US deficit spending (and perhaps some other issues) jeopardizes the value of the US dollar.
And, in fact, the argument also runs that the Japanese, British, European deficits are worse, and so *those* currencies are threatened.

So which do you choose? The argument goes the US is closer to 'normal' economic environment and so interest rates are more likely to go up there first thus pulling the dollar up.
Do we have reason to believe that investors world-wide are not aware of the existence and effect of currency value fluctuations?
No. But how much risk do you want to take as a USD based investor, with US consumption for most of your main bills (housing, healthcare etc.).

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Re: 30% In International Stocks?

Post by nisiprius » Thu Nov 13, 2014 8:09 am

kenner wrote:Is it possible that the US dollar could lose value? If it does lose value at some point (say 10%) what will happen to relative values of international stock indexes vs. US stock indexes? IIRC, some people argue that US deficit spending (and perhaps some other issues) jeopardizes the value of the US dollar.
The U.S. dollar lost about 1/3 of its value between 2002 and 2008, and some back-of-the-envelope calculations I made once suggests that accounts for something like 2/3 of the outperformance shown by international stocks during the "lost decade." Yes, it works both ways. And it is a significant effect (unlike cost differences, which IMHO aren't).
Do we have reason to believe that investors world-wide are not aware of the existence and effect of currency value fluctuations?
Of course they are aware of it, but what can they do about it? The issue is not return, it's risk. Currency fluctuations add additional fluctuation and volatility to any asset that is not purchased in the home currency. That is a form of risk. That risk is experienced only by foreign investors. Home-country investors can invest without incurring that risk. Therefore it is risk that need not be taken, and it seems unlikely that the market rewards risk that does not need to be taken.

The expected return of currency fluctuation is, I think, generally believed to be zero.

Thus, the expected effect of currency fluctuation on foreign assets is that it adds risk without adding return. That makes it a less good investment in itself than home-currency assets.

Given equal intrinsic quality--if international stocks measured in their home currency had the same risk-adjusted return as U.S. stocks--then to a U.S. investor international stocks would be a less-good investment because of currency risk adding risk without return.

We can see this in Morningstar's 15-year Sharpe ratios: 0.21 for Vanguard Total International, 0.28 for Vanguard Total [U.S.] Stock Market Index.

So it comes down to a third factor. Currency risk makes non-home-country investments less good investments than home-country investments in themselves, but what to they do for the portfolio as a whole? It is stated and I believe it to be true that currency fluctuation has low correlation with stock prices. So, you effectively have an asset that does not increase or decrease return, does add volatility, but also has low correlation with stocks. So you need to ask two questions.

a) Is it even possible for a zero-return, high-volatility, low-correlation asset to improve a portfolio? I think this is a mathematical impossibility, UNLESS the correlation is truly negative, not just for a fleeting moment, but permanently, robustly, strongly, over the long term. (Such an asset would actually remove, erases, or cancels out risk, which I believe to be the financial equivalent of perpetual motion).

b) Even if it were possible, it would be a balancing act. The zero return doesn't hurt or help. The extra volatility hurts. Some people think the low correlation helps. Does it help more than it hurts?

Look, there is plenty of room for difference in view, but please let's stop saying that currency fluctuations don't have any effect on where the optimum is. And if we are basing our decisions on our "views" of macroeconomic futures--that is to say, we foresee a dim future for U.S. stocks and that leads us to shift our asset allocation--fine, but let's say that is what we are doing, and not just say "cap-weighting is correct for a basket of assets denominated in our home currency, therefore it must be correct for a basket of assets denominated in multiple currencies."
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Re: 30% In International Stocks?

Post by BigOil » Thu Nov 13, 2014 8:23 am

This is a fairly interesting thread. Thoughtful as well. Nisi, as usual, add some pretty clearheaded thinking.

When I thought about international investing %, I really really gave the Vanguard academic view a lot of weight. It is explained in their white papers on their site pretty well as well as in the excerpts above. I consider myself a pretty smart guy education-wise, with a pretty strong "top-20" pedigrees in business and engineering (i.e. numbers) --- I note that's no different than many people in Wall Street, or the other "product peddlers" of mutual investments. But I'm not about to be arrogant enough to second guess the experts at Vanguard, specifically!

I'll always consider Vanguard motivations as MOST aligned with with my motivations as an Investor... Fiduciary, plus not-profit or sales-motivated to shareholders... It just doesn't get any better for a customer than that. No, they're they're not perfect... But purchasing advice (contained in mutual funds implicitly or explicity) the issue is never how smart you/they can be it's what are the motivations of the seller. Most investors would be very very unwise to deviate significantly from the broad brush Vanguard advice on diversification... Including international. We cannot control the outcome ($ returned) of the decision, BUT the decision process, at a given moment, has an optimal answer. And that to me is by far the easiest to get at...Vanguard-aligned diversification.

A lot of people here spent a lot of time trying to out-think, humans never learn. Spock(yes, Star Trek) should be a Fincial Advisor! LOL

Finally, there should be a weak mention, of the reduced standard deviations (risk) by adding international. Generally speaking the international and United States markets are not perfectly correlated --- though there definitely is some correlation in markets globally --- so by adding international you reduce risk. And I think generally the returns are somewhat similar. Trying to guess which markets will return more is a fools errand in my mind. Back testing is interesting for framing the issue, but provides very little decisions value.

I simply choose accept the risks, for the reward potential. And, I fundamentally believe in capitalism and democracy, and in the motivations of those who set the rules and play/set in the Markets to wanna make money for themselves... And ultimately, we all benefit from this if we participate. Even outside the highly-trasmparent and regulated USofA stocks ...

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Re: 30% In International Stocks?

Post by kenner » Thu Nov 13, 2014 8:27 am

Valuethinker and Nisiprius,

Thank you both for your comments. I've learned a lot about a subject I've never really paid much attention to.

Ken

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Re: 30% In International Stocks?

Post by backpacker » Thu Nov 13, 2014 4:03 pm

nisiprius wrote: a) Is it even possible for a zero-return, high-volatility, low-correlation asset to improve a portfolio? I think this is a mathematical impossibility, UNLESS the correlation is truly negative, not just for a fleeting moment, but permanently, robustly, strongly, over the long term. (Such an asset would actually remove, erases, or cancels out risk, which I believe to be the financial equivalent of perpetual motion).
David Swenson has this to say in his book Unconventional Success:
David Swenson wrote: Fortunately, finance theorists conclude that some measure of foreign exchange exposure adds to portfolio diversification. Unless foreign currency positions constitute more than roughly one-quarter of portfolio assets, currency exposure serves to reduce overall portfolio risk. Beyond a quarter of portfolio assets, the currency exposure constitutes a source of unwanted risk.
The upshot is that investors should hold at least 25% of total assets in foreign stocks since, up until that point, foreign currency risk is a feature rather than a bug.*

*Assuming that they can hold their international stocks in a taxable account without diverting funds from tax advantaged accounts. The other major reason to avoid international stocks is that international stocks have an annualized tax disadvantage of about .2% when held in a tax advantages account. For investors with enough taxable space, this is irrelevant. Those investors can also invest in Vanguard funds with low fees, so don't have to worry about paying high fees to buy foreign stocks. Investors with only tax advantaged accounts need to weigh these other factors as well.

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Re: 30% In International Stocks?

Post by kenner » Thu Nov 13, 2014 8:51 pm

backpacker wrote:
nisiprius wrote: a) Is it even possible for a zero-return, high-volatility, low-correlation asset to improve a portfolio? I think this is a mathematical impossibility, UNLESS the correlation is truly negative, not just for a fleeting moment, but permanently, robustly, strongly, over the long term. (Such an asset would actually remove, erases, or cancels out risk, which I believe to be the financial equivalent of perpetual motion).
David Swenson has this to say in his book Unconventional Success:
David Swenson wrote: Fortunately, finance theorists conclude that some measure of foreign exchange exposure adds to portfolio diversification. Unless foreign currency positions constitute more than roughly one-quarter of portfolio assets, currency exposure serves to reduce overall portfolio risk. Beyond a quarter of portfolio assets, the currency exposure constitutes a source of unwanted risk.
The upshot is that investors should hold at least 25% of total assets in foreign stocks since, up until that point, foreign currency risk is a feature rather than a bug.*

*Assuming that they can hold their international stocks in a taxable account without diverting funds from tax advantaged accounts. The other major reason to avoid international stocks is that international stocks have an annualized tax disadvantage of about .2% when held in a tax advantages account. For investors with enough taxable space, this is irrelevant. Those investors can also invest in Vanguard funds with low fees, so don't have to worry about paying high fees to buy foreign stocks. Investors with only tax advantaged accounts need to weigh these other factors as well.
Now I'm thoroughly confused. Either exposure to currency fluctuations via international stock investing can be beneficial to a US investor or it cannot.

So, is Yale University's star David Swensen right?

IIRC, in the decade prior to the 2008 financial meltdown, international stocks returned double the total return of US stocks. Even if that was caused by currency fluctuations, that is the kind of diversification I can embrace.

What am I missing?

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Re: 30% In International Stocks?

Post by nisiprius » Thu Nov 13, 2014 9:17 pm

kenner wrote:
backpacker wrote:
nisiprius wrote: a) Is it even possible for a zero-return, high-volatility, low-correlation asset to improve a portfolio? I think this is a mathematical impossibility, UNLESS the correlation is truly negative, not just for a fleeting moment, but permanently, robustly, strongly, over the long term.
David Swenson has this to say in his book Unconventional Success:
David Swenson wrote: Fortunately, finance theorists conclude that some measure of foreign exchange exposure adds to portfolio diversification. Unless foreign currency positions constitute more than roughly one-quarter of portfolio assets, currency exposure serves to reduce overall portfolio risk. Beyond a quarter of portfolio assets, the currency exposure constitutes a source of unwanted risk.
...
Now I'm thoroughly confused. Either exposure to currency fluctuations via international stock investing can be beneficial to a US investor or it cannot. So, is Yale University's star David Swensen right?
I don't know. I believe what I believe. I haven't read the Swensen book. Does he name the "finance theorists" and the relevant papers? I think the only way they can possibly be right if they are making some strong assumptions I don't know about, assumptions that are outside the scope of modern portfolio theory, beyond "low correlation" or "zero correlation," some kind of persistent "tends-to" pattern or something of that sort.

I really think "zero return can improve a portfolio if there is zero correlation" is a fairly obvious impossibility. To believe that, you have to believe that it would be beneficial to your portfolio to keep 10% of your portfolio in cash, and every week meet someone and bet it on a fair coin flip, then rebalance.
IIRC, in the decade prior to the 2008 financial meltdown, international stocks returned double the total return of US stocks. Even if that was caused by currency fluctuations, that is the kind of diversification I can embrace.

What am I missing?
Well, I could say "Swensen says 25%, so cap-weighted is NOT the optimum."

But what you're missing is that sometimes it will work the other way. Life is not all 2002-2008's. From inception to 2007, Total International and Total Stock are almost tied. The period of outperformance 2002-2008 is almost perfectly balanced by the period of underperformance that preceded it. Since inception, Total International has had one period of outperformance and two periods of underperformance and overall, is far behind. Each of these periods lasted around six years, so in effect Total International is only three data points, and the entire time period since the first international index, 1970-2014, 44 years, is only about eight.

It's not about 2002-2008. It's about whether, over long periods of time, the 2002-2008's are going to collectively outweigh the 1995-2002's and the 2008-2014's, and by how much.

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Re: 30% In International Stocks?

Post by nisiprius » Thu Nov 13, 2014 9:19 pm

But we're wandering off-topic and I'm allowed myself to resurrect an endless debate. My apologies.

To get back to what humdrum is asking, he wants to move from having 33% of his stocks international to having 50% of his stocks international, and is asking whether 50% international is too much.
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Re: 30% In International Stocks?

Post by kenner » Thu Nov 13, 2014 10:04 pm

Thanks again, Nisi. Seems to me that TSM and TISM are generally quite highly correlated, with sporadic periods of divergence. Though diversification benefits may be limited, they still can sometimes occur. I may be wrong, but it seems like maybe you are talking about total return while I'm talking about TISM "zigging" while TSM "zagged" (at least from 2002 - 2008).

As far as Humdrum's situation, one-third TISM seems middle of the road, 50% TISM at the nether reaches.
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Re: 30% In International Stocks?

Post by SimpleGift » Thu Nov 13, 2014 10:12 pm

Not mentioned so far is that adding international stocks and their currency risk can also provide a valuable diversification benefit against domestic fiscal and monetary policy. For example, domestic inflationary pressures are usually bad for domestic bonds and stocks and often lead to currency depreciation. Owning "currency risk," even though it has zero expected return, helps to hedge against such outcomes.
Cordially, Todd

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Re: 30% In International Stocks?

Post by nisiprius » Thu Nov 13, 2014 10:23 pm

kenner wrote:Thanks again, Nisi. Seems to me that TSM and TISM are generally quite highly correlated, with sporadic periods of divergence. Though diversification benefits may be limited, they still can sometimes occur.
Sure. The correlation of U.S. Large Company Stocks and "International Stocks" from 1970-2009 was 0.66 according to the SBBI 2010 Classic Yearbook.

It's all sort of indefinite mush.

The same sources says the standard deviation of international stocks was 23.1, U.S 18.1. So, international stocks are a little riskier or more volatile than U.S. stocks, yes they are, they are, they really are, just like the silly prospectus says--but not much riskier. And their Sharpe ratio, at least for the last 15 years, is a little lower, less return for the risk.

But the correlation is 0.66 which is not 1.00 but is not really very low, either--it's not like stocks and bonds, which are close to zero.

So you get a little extra risk, but not much, and you get a little extra diversification, but not much, and people are so darned sure they know what the optimum mix when the real question is whether the difference between the optimum mix and the suboptimum is going to be enough to notice.

Sure, if you were invested from 2002-2008 and you weren't invested from 1995-2002 then it makes a noticeable difference--the more international the better, and the optimum would have been 100% international. And from 1995-2002 it would have been 100% U.S....
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Re: 30% In International Stocks?

Post by Kalo » Fri Nov 14, 2014 12:15 am

I think a good reason to hold some international (I have about 30% of equities in TISM) is simply because of single country risk. No matter how many arguments one makes in favor of the US, it's still a single country. I'm even a citizen, and believe in our system, but things do happen to an individual country some times.

There's not much point in my listing out the types of things I'm thinking of. Recency bias can make one feel that the US is immune from mega disasters or slow but progressive decline. I hope we are, but I'm not willing to bet the entire equity portion of my portfolio on it. The thought of country specific deep risk makes me more comfortable holding 20% of my total portfolio in TISM.

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Re: 30% In International Stocks?

Post by selters » Fri Nov 14, 2014 8:24 am

kenner wrote:
Humdrum wrote:I wholeheartedly agree that "past performance is not a guarantee of future returns". As it is, U.S. stocks are currently going through the roof whereas International stocks aren't doing so well. This coupled with the fact that in the next decade International stocks are projected to be doing very well. So I am just wondering if a 50/50 split between International/U.S. in the equity part of an AA would provide a good balance?
One way to look at this: Millions of investors world-wide have already determined that US and International equities warrant a roughly 50/50 split. Given the perceived advantages of index/market weight investing, why would an individual investor want to deviate from global weightings?
For tax reasons. Governments in most developed countries withhold about 15% of dividends. In tax deferred accounts you never get these 15% back.

International stocks have a gross yield of about 3%. A 15% withholding tax equates to an additional 45 basis points added to the annual expense ratio.

If one expects stocks to return 4.5% annually over the next decade, investing in international stocks is like giving away 10% of one's expected return.

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Re: 30% In International Stocks?

Post by rai » Fri Nov 14, 2014 8:50 am

Just had a side question, but I'm trying to figure ifInternational are worse than US stocks outside of a tax shelter? Or the same?

For my personal situation, I am in the top US tax bracket, full Medicare tax on dividends as well.


I thought you get some type of foreign tax credit if you hold internationals in taxable account, by the way I hold both US and exUs in both tax shelter and taxable accounts but was curious if there is a difference or which is better to be in the shelter?

Thanks
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Re: 30% In International Stocks?

Post by Valuethinker » Fri Nov 14, 2014 9:46 am

Kalo wrote:I think a good reason to hold some international (I have about 30% of equities in TISM) is simply because of single country risk. No matter how many arguments one makes in favor of the US, it's still a single country. I'm even a citizen, and believe in our system, but things do happen to an individual country some times.

There's not much point in my listing out the types of things I'm thinking of. Recency bias can make one feel that the US is immune from mega disasters or slow but progressive decline. I hope we are, but I'm not willing to bet the entire equity portion of my portfolio on it. The thought of country specific deep risk makes me more comfortable holding 20% of my total portfolio in TISM.

Kalo
The UK has had slow but progressive decline for roughly a century (relative to everyone else, some date it from the late 1800s). Stock market has done well, in the end.

Mega disasters? Well let's say that setting aside some total political breakdown, the US is so large and diverse geographically that it has an inherent degree of protection. In fact its biggest vulnerability was hydrocarbon imports (excepting Canada and Venezuela) and that, in fact, is shrinking fast right now.

But your general point is a good one. *Some* diversification is good news.

Anyone outside the US would not ignore the US market. indeed I would for most countries argue for global market cap weighting.

US is a bit unique, a VG US investor can save significant management and tax costs by being in the US. So aim off 45-50% foreign stocks, down to 20-30% and get some benefits from international diversification, but less of the costs.

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Re: 30% In International Stocks?

Post by rkhusky » Fri Nov 14, 2014 10:20 am

rai wrote:Just had a side question, but I'm trying to figure ifInternational are worse than US stocks outside of a tax shelter? Or the same?

For my personal situation, I am in the top US tax bracket, full Medicare tax on dividends as well.


I thought you get some type of foreign tax credit if you hold internationals in taxable account, by the way I hold both US and exUs in both tax shelter and taxable accounts but was curious if there is a difference or which is better to be in the shelter?

Thanks
Less of international dividends are of the qualified variety, which partially counterbalances the foreign tax credit. The net result depends on your tax bracket and the sizes of the dividend yields for US and Int'l.

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Re: 30% In International Stocks?

Post by backpacker » Sat Nov 15, 2014 11:50 am

selters wrote: For tax reasons. Governments in most developed countries withhold about 15% of dividends. In tax deferred accounts you never get these 15% back.

International stocks have a gross yield of about 3%. A 15% withholding tax equates to an additional 45 basis points added to the annual expense ratio.

If one expects stocks to return 4.5% annually over the next decade, investing in international stocks is like giving away 10% of one's expected return.
+1

This is one of the very few legitimate reason IMO to tilt towards domestic stocks. I have a 50/50 split in part because I can hold all my international in taxable (and get the foreign tax credit to offset the foreign withholdings). If all my investments were in tax-advantaged accounts, I would also tilt towards domestic stocks for precisely this reason.
Last edited by backpacker on Sat Nov 15, 2014 11:52 am, edited 1 time in total.

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Re: 30% In International Stocks?

Post by hafius500 » Sat Nov 15, 2014 11:51 am

nisiprius wrote:
kenner wrote:
backpacker wrote:
nisiprius wrote: a) Is it even possible for a zero-return, high-volatility, low-correlation asset to improve a portfolio? I think this is a mathematical impossibility, UNLESS the correlation is truly negative, not just for a fleeting moment, but permanently, robustly, strongly, over the long term.
David Swenson has this to say in his book Unconventional Success:
David Swenson wrote: Fortunately, finance theorists conclude that some measure of foreign exchange exposure adds to portfolio diversification. Unless foreign currency positions constitute more than roughly one-quarter of portfolio assets, currency exposure serves to reduce overall portfolio risk. Beyond a quarter of portfolio assets, the currency exposure constitutes a source of unwanted risk.
...
Now I'm thoroughly confused. Either exposure to currency fluctuations via international stock investing can be beneficial to a US investor or it cannot. So, is Yale University's star David Swensen right?
I don't know. I believe what I believe. I haven't read the Swensen book. Does he name the "finance theorists" and the relevant papers? I think the only way they can possibly be right if they are making some strong assumptions I don't know about, assumptions that are outside the scope of modern portfolio theory, beyond "low correlation" or "zero correlation," some kind of persistent "tends-to" pattern or something of that sort.

I really think "zero return can improve a portfolio if there is zero correlation" is a fairly obvious impossibility. To believe that, you have to believe that it would be beneficial to your portfolio to keep 10% of your portfolio in cash, and every week meet someone and bet it on a fair coin flip, then rebalance.
IIRC, in the decade prior to the 2008 financial meltdown, international stocks returned double the total return of US stocks. Even if that was caused by currency fluctuations, that is the kind of diversification I can embrace.

What am I missing?
Well, I could say "Swensen says 25%, so cap-weighted is NOT the optimum."

But what you're missing is that sometimes it will work the other way. Life is not all 2002-2008's. From inception to 2007, Total International and Total Stock are almost tied. The period of outperformance 2002-2008 is almost perfectly balanced by the period of underperformance that preceded it. Since inception, Total International has had one period of outperformance and two periods of underperformance and overall, is far behind. Each of these periods lasted around six years, so in effect Total International is only three data points, and the entire time period since the first international index, 1970-2014, 44 years, is only about eight.

It's not about 2002-2008. It's about whether, over long periods of time, the 2002-2008's are going to collectively outweigh the 1995-2002's and the 2008-2014's, and by how much.

Image
How can we know if currency losses or lower stock returns in local currencies explain the underperformance?
This is a longer period:
TweedyFund Commentary Q3 2014:
"Average annaul total returns from 6/15/93 through 9/30/2014"
5,53 % MSCI EAFE USD
5,88 % MSCI EAFE Hedged ("Consists of the results of the MSCI EAFE Index 100% hedged back into U.S. dollars and accounts for interest differentials in forward currency exchange rates. Index results are inclusive of dividends and net of foreign withholding taxes")
Is this difference consistent with huge currency losses?

Dou you have any papers that specify how much risk a basket of foreign currencies adds to a domestic stock portfolio?
Don't forget that you don't invest in a single foreign currency.
We have seen, however, that even for single country investments, exchange risk does not greatly increase portfolio risk, and its impact is even smaller in the context of internationally diversified portfolios. Indeed, unhedged international portfolios might even have lower long-term variability than their hedged equivalents in real terms.
(Triumph of the Optimists, p.108)

If we ignore currency risk we add foreign stocks to reduce the risks of being invested in a single market (economy). Of course, you may think you don't need such diversification.
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Re: 30% In International Stocks?

Post by hafius500 » Sat Nov 15, 2014 12:26 pm

nisiprius wrote:
z3r0c00l wrote:
kenner wrote:
One way to look at this: Millions of investors world-wide have already determined that US and International equities warrant a roughly 50/50 split. Given the perceived advantages of index/market weight investing, why would an individual investor want to deviate from global weightings?
Exactly. If market cap indexing works for US stocks, why would it not be the same system for an investor globally?
Because of currency risk, which, for a U.S. investor, exists for international stocks and not for U.S. stocks. If we had a single global currency, it would be the same, but we don't, so it isn't.

It's possible to argue about the effect and the importance of currency risk, but it's there and it means that the argument for cap-weighting domestic stocks does NOT carry over unchanged for global stocks.

Over the last six months, for example, the dollar index has increased by about 10%, and over that period of time VGTSX has fallen about 10% behind VTSMX. In short, the recent underperformance of VGTSX is just about explained by currency risk, specifically the strengthening dollar.
I repeat the question I asked in my second post: Can we figure out how great the currency risk is and what role it should play in our asset allocation? Any papers? The usual recommendations (x% international) are not more than guesses IMO.
For example, I haven't seen a paper that suggests that a single currency is necessary to recommend global cap-weighting, e.g.:

This paper on a global CAPM does not mention currency risks or a single currency:

Asset Pricing in Emerging Markets - Campbell R. Harvey
In an international setting, this assumption also means that markets are perfectly integrated. This means the following: the same risk asset commands the same expected return regardless of location (country)...
With capital market integration, we get a world version of the Capital Asset Pricing Model. That is, assets within a particular country are rewarded in terms of their contribution to a well-diversified world portfolio. What matters is the covariance with the world portfolio. There is also a world price of covariance risk that translates the contribution into expected returns. The world price is directly linked to the weighted average risk aversion in the world. Higher risk aversion implies a higher world price of covariance risk...
In the integrated world, a country portfolio’s risk is its covariance with world returns. This covariance is rewarded with a common world price which is linked to weighted average risk aversion in the world. In the segmented world, a country portfolio’s risk is it variance. The variance is rewarded with a country specific price which is linked to a weighted average risk aversion within the particular country...
In an integrated world, local companies will be influenced by the same type of world shocks...For example, if the U.S. falls into recession, this is bad news for many stocks in developed countries because the U.S. is a major consumer of their goods.
Finance theory dictates that investors should hold the broadest of all possible portfolios, each country weighted by its market value, to achieve maximal diversification
(Siegel, Future for Investors, p.232)
We concluded that an investor with no stock selection skills should hold as widely diversified portfolio as possible, thus avoiding exposure to diversifiable, and hence unrewarded, risk. This effectively means holding a stake in the overall market. The same principle holds when investing internationally. Risk can be reduced as the returns on different markets and currencies are less than perfectly correlated. Investors with no special insights about the prospects for different markets and currencies should, like their domestic counterparts, hold as widely diversified a portfolio as possible. If it were not for market imperfections and differences in tastes they should hold the "world market portfolio".
(Dimson, Triumph of the Optimists, p.108)

Vanguard- "International Investing. Considerations" (no link and quotes available):
Page 3: finance theory suggests cap-weightings and in the long run currency movements should have no impact on the return of the portfolio.

Finally, a domestic investor is still exposed to currency risks unless this country does not import or export goods or services.
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Re: 30% In International Stocks?

Post by backpacker » Sat Nov 15, 2014 12:35 pm

nisiprius wrote:
backpacker wrote:
nisiprius wrote: a) Is it even possible for a zero-return, high-volatility, low-correlation asset to improve a portfolio? I think this is a mathematical impossibility, UNLESS the correlation is truly negative, not just for a fleeting moment, but permanently, robustly, strongly, over the long term.
David Swenson has this to say in his book Unconventional Success:
David Swenson wrote: Fortunately, finance theorists conclude that some measure of foreign exchange exposure adds to portfolio diversification. Unless foreign currency positions constitute more than roughly one-quarter of portfolio assets, currency exposure serves to reduce overall portfolio risk. Beyond a quarter of portfolio assets, the currency exposure constitutes a source of unwanted risk.
I haven't read the Swensen book. Does he name the "finance theorists" and the relevant papers? I think the only way they can possibly be right if they are making some strong assumptions I don't know about, assumptions that are outside the scope of modern portfolio theory, beyond "low correlation" or "zero correlation," some kind of persistent "tends-to" pattern or something of that sort.
Swenson doesn't unfortunately, but halfius500's reference from Triumph of the Optimists may give us a clue to what's going on. The following is a chart from the book showing real standard deviation of foreign stock returns, real standard deviation for currency rates, and the correlation between the two. What they find is that real international currency changes by and large have a moderately negative correlation with real international stock returns.

Image

This doesn't fully explain the Swenson point. Maybe there is also a negative correlation between international exchange rates and US equity returns? That would explain why currency risk can improve a us stock portfolio. That there should be such a negative correlation is economically intuitive. As the dollar drops against foreign currencies, exports become cheaper and foreign sales go up. As the dollar appreciates against foreign currencies, exports become more expensive and foreign sales drop. Papers like this one find precisely this sort of negative correlation.

So my position by now, I think, is that ignoring tax considerations, there is no good reason not to hold stocks at global market weight. But tax considerations are important for investors who can't hold their international stocks in a tax advantaged account. Such investors have real financial reason to hold international stocks at less than market weights. This also justifies Vanguard's underweighting of international stocks in its target date funds. Such funds are typically held in tax advantaged accounts, accounts where domestic stocks have a real advantage over international stocks.

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Re: 30% In International Stocks?

Post by aaronl » Sat Nov 15, 2014 12:52 pm

selters wrote:For tax reasons. Governments in most developed countries withhold about 15% of dividends. In tax deferred accounts you never get these 15% back.

International stocks have a gross yield of about 3%. A 15% withholding tax equates to an additional 45 basis points added to the annual expense ratio.

If one expects stocks to return 4.5% annually over the next decade, investing in international stocks is like giving away 10% of one's expected return.
This line of reasoning only makes any sense if you expect very similar return from domestic and international stocks.

I tilt heavily towards international stocks because I'm expecting other stock markets to significantly outperform the USA's in the medium to long term.

Even if you give up 45 basis points of the dividend yield from international stocks, you're still looking at a higher yield than you get from American stocks. Yield isn't everything, but it means that even with the tax disadvantages you get more cash flow from international stocks, and it's a signal that international stocks may have more attractive valuations.

It's been interesting to watch the debate in this thread about whether 30-50% international is too much. My equity portfolio is presently 75% international, and I'm looking to underweight US stocks even more.

The bottom line is I have trouble believing that US stocks will have promising returns going forward. A lot of people have commented on US stock valuations, but I particularly like the analysis at http://www.philosophicaleconomics.com/2014/08/capehigh/, especially the section at the end where the author lays out possible future scenarios. I would rather take my chances with other countries that face big challenges than simply hope the US stock market will grind higher and higher.

I also feel that underweighting US stocks balances my US-centric real estate portfolio.

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Re: 30% In International Stocks?

Post by WHL » Sat Nov 15, 2014 12:59 pm

I run 50/25/25. I'm not smart enough to figure out what percentage of my equities are international, but I think it's 35-40%

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Re: 30% In International Stocks?

Post by nisiprius » Sat Nov 15, 2014 1:11 pm

Backpacker, I got confused between two different points. There are two different questions. The one I was fixated on, to the point where I wasn't listening to what you were saying about Swensen, is this:

Consider asset C, for "currency volatility," and suppose it has ZERO return, HIGH volatility, and LOW BUT NOT NEGATIVE correlation with stocks.

Consider asset I, for "international stocks" and suppose it has SIMILAR return, SIMILAR volatility, and what I'll call "medium" correlation (0.66). Asset I is a combination of intrinsic diversification (different businesses, different economies) and currency volatility.

Can asset C alone improve a portfolio? I say no. You cannot improve your portfolio by betting 10% of it every week on a fair coin flip.

Can asset I improve a portfolio? Yes, it can.

So I'm not contradicting Swensen, because I was talking about pure currency volatility, and he was talking about international stocks.

Next question. What's the optimum allocation of asset I? Is it cap-weighted (50%) or is it less than cap-weighted? According to you, Swensen says the optimum is at 25%.

In the absence of currency volatility (according to textbook theory, which makes assumptions which can be challenged but we won't), the optimum would be cap-weighted.

On the one hand, everything I've ever read that looks at past data--for example, simply taking the past mean, standard deviation, and correlations between EAFE and the S&P 500 over the period of time EAFE has existed--consistently show the optimum to be much lower than cap-weighted, somewhere around 1/3.

On the other hand, all of the numbers that go into MPT calculation are crazy-imprecise and jump around like mad depending on what time period you look at. To state the obvious without bothering to do the calculations, if you were to do an MPT calculation using the mean, standard deviation, and correlations for the period 2002-2008 I'm confident the optimum would be 100% international; for 1995-2002, 100% U.S.

But going back to Swensen's 25%, Vanguard's choice of 30% in its all-in-one funds, Fidelity's indication of an optimum at around 30% in a similar analysis... my belief is that the explanation of my the optimum is lower than cap-weighted is precisely because of the presence of currency volatility, and that currency volatility is bad because high volatility with zero return is always bad no matter how low the correlation is.

International is good, but it is less good than it might be because of currency volatility. And because of that, the optimum weighting of international is less than cap-weighted.
Last edited by nisiprius on Sat Nov 15, 2014 4:57 pm, edited 1 time in total.
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Re: 30% In International Stocks?

Post by retiredjg » Sat Nov 15, 2014 1:43 pm

WHL wrote:I run 50/25/25. I'm not smart enough to figure out what percentage of my equities are international, but I think it's 35-40%
How about 33.3%?

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