Matter/Scatter Part 5: International stocks

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nisiprius
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Matter/Scatter Part 5: International stocks

Post by nisiprius »

Part 1: Introduction, Part 2: Bond fund choices,, Part 3, International bonds, Part 4: Bond allocation Brief notes: 1) In these Monte Carlo simulations in which the return for a given month is varied by randomly choosing the actual historical return or the actual historic return for an adjacent month. 2) They show the final value from $100 monthly contributions made over the whole time period. 4) Green and red crosses mark actual historical values. 5) Green and red bars show the 10% percentile, median, and 90% percentile of the range of outcomes. 5) The actual data source is PortfolioVisualizer.com, Backtest Portfolio, Monthly Returns; this is used as calculation input; and no PV content or numeric values are directly reproduced.

It is very widely suggested that investors include an allocation to international stocks. How much to include is one of the most frequently discussed topics in the forum. For our first comparison, we will start with a 60/40 all-US portfolio and see the effect of replacing 30% of the US stocks with international stocks. In order to get the longest possible comparison time, I've used VFINX, 500 index (instead of Total Stock), and I've used an actively managed fund, FDIVX, Fidelity Diversified International, instead of Total International. Note that FDIVX has outperformed FGTSX handily, so I haven't stacked the deck against international by using it. 30% international is a compromise number. At the start of the period, conventional wisdom would have suggested a much lower allocation. Lately, the conventional wisdom has moved to higher suggested allocations. (Our second comparison will use a higher allocation).

Image

Higher international allocations are often suggested nowadays, and it is often suggested that emerging markets not only be included, but overweighted. For our next comparison, we will use a set of allocations created by the Wealthfront website, for a 40-year-old investor with middling answers to all the "risk" questions. Wealthfront is advised by Burton Malkiel, author of A Random Walk Down Wall Street, who was on the Vanguard board for over thirty years. That allocation will be the "comparison." The "baseline" will be a similar portfolio, but US-only. I've chosen funds that I think fit the categories reasonably well, and that have long track records. The Wealthfront allocation is:

Image

For our comparison:
U.S. Stocks 35%: VTSMX, Vanguard Total Stock Market Index
Foreign stocks 23%: VGTSX, Vanguard Total International Stock Index
Emerging markets 15%: VEIEX, Vanguard Emerging Markets Stock Index
Dividend stocks 7%: VEIPX, Vanguard Equity-Income
Municipal bonds 20%: VWITX, Vanguard Intermediate-Term Tax-Exempt

For our US-only baseline:
U.S. Stocks 35% + 23% + 15% = 73%: VTSMX, Vanguard Total Stock Market Index
Dividend stocks 7%: VEIPX, Vanguard Equity-Income
Municipal bonds 20%: VWITX, Vanguard Intermediate-Term Tax-Exempt

Image

The allocation with international stocks happened to have both lower return and higher risk during this particular time period. More important in the context of "how much it matters," the change produced a $5,000 difference in return, in portfolios that had a simulated range of variation of $40,000.
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columbia
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Re: Matter/Scatter Part 5: International stocks

Post by columbia »

How early and how much you invest seemingly matters far more than if you decide to add any international. It’s an endless back and forth, so let that commence. ;)
asif408
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Re: Matter/Scatter Part 5: International stocks

Post by asif408 »

I'm currently reading a book titled Global Investing, by Ibbotson and Brinson, which was written in 1992 or 1993. In it, they highlight returns of stock markets throughout the world from 1970-1990, which includes the US. The US was near the bottom in returns among I believe 10-20 countries highlighted, though it was one of the lowest with respect to standard deviation, so maybe on a risk adjusted basis it wasn't as low. So considering that the US was one of the more poorly performing global stock markets in the previous 2 decades, it is not terribly surprising that it has been one of the best since then.

Based on your analysis and that data, it seems like these periods of outperformance between world markets can last multiple decades. I tend to agree with your observation that international stocks may not improve returns over an investor's lifetime. But it seems to me the strongest argument for international is not to increase returns, but to reduce risk. Specifically, the risk of putting most of your money in one or a few countries that have very poor returns over the coming decades. I found it interesting, for example, that in the book the authors mentioned how Japan weathered the 1973-1974 bear market pretty well, while the US and UK both got hit hard.

Maybe some other country in a future crash will not fall as hard and cushion the blow a bit. Maybe it won't matter. But since it's not terribly more expensive or inconvenient to hold foreign stocks, why not?
GAAP
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Re: Matter/Scatter Part 5: International stocks

Post by GAAP »

asif408 wrote: Wed Aug 01, 2018 8:40 am But it seems to me the strongest argument for international is not to increase returns, but to reduce risk. Specifically, the risk of putting most of your money in one or a few countries that have very poor returns over the coming decades.
Part of my reasoning also.

Is there sufficient data available to do a comparison with a truly global-weighted portfolio? My guess is no for anything beyond about 10 years.
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Re: Matter/Scatter Part 5: International stocks

Post by pokebowl »

International I feel is the one area where a lot of investor biases come into play for various reasons. In addition, I feel it is also the one area where back testing will provide a false sense of expected U.S. out-performance. Where U.S. was relatively unscathed from the various world wars and regional conflicts over the last century, many countries were not, which gave the U.S. in my personal opinion, a generational leap economically.

Will that success continue? I can't say, however for whatever reason this is the one area where, even though many echo "past performance is no guarantee of future results", "buy the haystack", "no one knows nothing", etc. Few want to follow their own advice. :beer
Daitokuji
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Re: Matter/Scatter Part 5: International stocks

Post by Daitokuji »

I am in 60% US/40% international as per Vanguard's official recommendation, but looking at the past decade of results that may not be the optimal allocation. Still, past performance is no guarantee of future results.

This is Vanguard's white paper on international allocation from 2014: https://www.vanguard.com/pdf/ISGGEB.pdf (Is there a newer version of this?)

In it, they recommend a minimum of 20% and up to the market cap % for international allocation. But their target date funds are at a 60/40 ratio and you get the same response if you ask a Vanguard advisor.
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Re: Matter/Scatter Part 5: International stocks

Post by MotoTrojan »

Daitokuji wrote: Wed Aug 01, 2018 1:58 pm
In it, they recommend a minimum of 20% and up to the market cap % for international allocation. But their target date funds are at a 60/40 ratio and you get the same response if you ask a Vanguard advisor.
It was 30% before the US CAPE overvalue talk really heated up and international stocks took off. Bit concerning on the recency bias but maybe it’ll work out.
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Re: Matter/Scatter Part 5: International stocks

Post by Dandy »

Where U.S. was relatively unscathed from the various world wars and regional conflicts over the last century, many countries were not, which gave the U.S. in my personal opinion, a generational leap economically.
How true. Having friendly neighbors ( I hope they are still friendly :happy ) and large oceans still provide a bit of an advantage. Also, fairly good resources, a stable government?, skilled/mobile workforce, regulated capitalism, etc. help. The emergence of rogue states with terrible/long range weapons/intentions is not a great development for any country.

If climate change/rising sea levels/inability to grow critical crops occurs any US economic advantage will be likely be sorely tested. Not sure that makes a case for international investing but maybe that some added diversity especially for those in the accumulation stage might be wise.
columbia
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Re: Matter/Scatter Part 5: International stocks

Post by columbia »

Dandy wrote: Wed Aug 01, 2018 5:03 pm
Where U.S. was relatively unscathed from the various world wars and regional conflicts over the last century, many countries were not, which gave the U.S. in my personal opinion, a generational leap economically.
How true. Having friendly neighbors ( I hope they are still friendly :happy ) and large oceans still provide a bit of an advantage. Also, fairly good resources, a stable government?, skilled/mobile workforce, regulated capitalism, etc. help. The emergence of rogue states with terrible/long range weapons/intentions is not a great development for any country.

If climate change/rising sea levels/inability to grow critical crops occurs any US economic advantage will be likely be sorely tested. Not sure that makes a case for international investing but maybe that some added diversity especially for those in the accumulation stage might be wise.

Were one to forecast future regional/global conflicts, geographic “isolation” of US would still be a major factor. Sometimes I scratch my head and wonder if other US investors really appreciate how much the cake is already baked in our favor.
petulant
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Re: Matter/Scatter Part 5: International stocks

Post by petulant »

These posts are very interesting and raise good questions. Thank you for putting them together.

It would also be helpful if the bar chart portion showing the 90/10 range had some scale for the density of outcomes across the bar. I think the scatter plots show density somewhat, but it’s hard to use the scatters.

For example, in the bond allocation post, we saw that a higher stock allocation appeared to have the best returns. But a clearer representation of dispersion would have been helpful, i.e. 80/20 has better ranges than 60/40, but 60/40 may have more density close to the mean, which is advantageous. If so, the part of the bar close to the middle could have been thicker in some way. People might find it helpful to get a thicker middle.
RadAudit
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Re: Matter/Scatter Part 5: International stocks

Post by RadAudit »

Nice work. Thanks for the posts.
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petulant
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Re: Matter/Scatter Part 5: International stocks

Post by petulant »

MotoTrojan wrote: Wed Aug 01, 2018 2:06 pm
Daitokuji wrote: Wed Aug 01, 2018 1:58 pm
In it, they recommend a minimum of 20% and up to the market cap % for international allocation. But their target date funds are at a 60/40 ratio and you get the same response if you ask a Vanguard advisor.
It was 30% before the US CAPE overvalue talk really heated up and international stocks took off. Bit concerning on the recency bias but maybe it’ll work out.
An important point is that the paper was written in 2014, so the last ~5 years of data is not informing their recommendation.
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Re: Matter/Scatter Part 5: International stocks

Post by AlphaLess »

columbia wrote: Tue Jul 31, 2018 5:30 pm How early and how much you invest seemingly matters far more than if you decide to add any international. It’s an endless back and forth, so let that commence. ;)
I don't trust the market efficiency of international markets:
- fees paid to acquire holding,
- country-level legal frameworks,
- possibility of being front-run by locals,
- etc

Just about 5-10 years ago, there was a cottage industry of stat arb prop desks in countries like Australia and Japan that all they would do is front run US-based asset managers.

Plus, US companies are sufficiently well-diversified.
"A Republic, if you can keep it". Benjamin Franklin. 1787. | Party affiliation: Vanguard. Religion: low-cost investing.
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