If riskier than US, why doesn't international outperform?

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samsdad
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If riskier than US, why doesn't international outperform?

Post by samsdad »

In another thread on international investing, this question was asked but didn't gain any traction (as of yet). I think it's a great question, perhaps the question, and have my theories but would like others' views as well.
staythecourse wrote: Tue Nov 13, 2018 4:57 pm
samsdad wrote: Tue Nov 13, 2018 4:44 pm Mr. Bogle’s views on capitalism, entrepreneurship, work ethic, transparency, law, corruption, and currency risk are basically shared by me after not only considered reflection, but also from my own experience living overseas.
Not trying to cause another debate, but trying to understand here. Since you stated the above is so obvious then shouldn't the U.S. only investor returns be LESS then the one who invests in international? IF U.S. is obviously safer then shouldn't they be discounted? If not then one is saying they don't believe in the "no free lunch" thought process, no?

It is this issue that I don't understand from the U.S. only investor. It seems they all (maybe I'm wrong) state the above and BECAUSE of that obvious safety still EXPECT it to outperform, i.e. more return for less risk? That simply doesn't make sense to me.

No one has been able to coherently explain this one aspect to me.

Thanks.

Good luck.
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Re: If riskier than US, why doesn't international outperform?

Post by jeffyscott »

If it were certain to outperform, it wouldn't be riskier.

There is never a guarantee that taking risk is going to pay off, that's the meaning of "risk". You can invest in riskier assets in the hope (or expectation) of obtaining higher returns, don't do it thinking that the riskier assets are certain to (eventually) provide higher returns.

Related to this, volatility is one aspect of risk, long term low returns or losses is another.
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Re: If riskier than US, why doesn't international outperform?

Post by Silk McCue »

If investment A is riskier than investment B within a given time horizon, and yet A consistently outperforms the less risky investment then it is no longer riskier and has been improperly defined. By definition risk suggests a wider range of results to the upside and downside, not an inclination to the upside.

An investment in a single stock is clearly more risky than buying the market and that extra risk doesn't equate to expected superior performance.

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Re: If riskier than US, why doesn't international outperform?

Post by nisiprius »

Luck.

From the start of the first international index in 1970, the MSCI EAFE index, there have been no systematic differences that are big enough to overcome the differences you can see due to choice of endpoints within that time period.

Over longer periods of time, e.g. the Dimson & Marsh data back to 1900, it's hard to know what to say. For one thing, it takes a real expert to know how to judge the reliability of the data. "Best available data" doesn't necessarily mean "good" data, and the more I read from Dimson et. al., the more I suspect them of gently grinding an axe.

For another thing, over long periods of time, the performance of national stock markets has been so obviously driven by major events of world history, that unless you are confident you can predict revolutions and world wars, you just to give up. Over long periods of time, everything is obviously dominated economic good luck of the United States, and the economic bad luck of Europe, during World War I and II.
Last edited by nisiprius on Fri Nov 16, 2018 8:41 am, edited 1 time in total.
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Re: If riskier than US, why doesn't international outperform?

Post by rkhusky »

The way the statement should be framed is that "investors should demand more return for taking more risk". This is quite different from "investors will get more return for taking more risk".

If investors find that the return of an asset class is not sufficient for the level of risk taken, they should logically stop investing in that asset class. This will cause the value of the asset class to drop, such that new investors may now find that the expected return does match the level of risk. It's a constant feedback loop that, in an efficient market, will cause risk and return to be correlated in some fashion.
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Re: If riskier than US, why doesn't international outperform?

Post by columbia »

The conversation is more interesting (and I’d argue more relevant), if you substitute “necessary” for “riskier.”
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Re: If riskier than US, why doesn't international outperform?

Post by Rick Ferri »

There isn't always a clear relationship between risk & return ex-post. The clear relationship is between expected risk and expected return ex-ante. We judge risk, estimate a payoff for taking that risk, then either walk away or dive in. There are no guarantees.
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Re: If riskier than US, why doesn't international outperform?

Post by jminv »

You don't necessarily receive a correspondingly higher return for taking on more risk. If you did, it would be a sure thing and everyone would pile into the riskier asset. Instead, you would expect to receive a higher return. Expectations don't always come true and that can be particularly true in the short to medium run with investing.
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Re: If riskier than US, why doesn't international outperform?

Post by staythecourse »

nisiprius wrote: Fri Nov 16, 2018 8:36 am Luck.

From the start of the first international index in 1970, the MSCI EAFE index, there have been no systematic differences that are big enough to overcome the differences you can see due to choice of endpoints within that time period.

Over longer periods of time, e.g. the Dimson & Marsh data back to 1900, it's hard to know what to say. For one thing, it takes a real expert to know how to judge the reliability of the data. "Best available data" doesn't necessarily mean "good" data, and the more I read from Dimson et. al., the more I suspect them of gently grinding an axe.

For another thing, over long periods of time, the performance of national stock markets has been so obviously driven by major events of world history, that unless you are confident you can predict revolutions and world wars, you just to give up. Over long periods of time, everything is obviously dominated economic good luck of the United States, and the economic bad luck of Europe, during World War I and II.
Bingo. America is no "safer" then ex US developed to invest money. Finance theory backs that up otherwise its returns should be LESS then international. Last 20+ years has shown that the ex post returns are in fact GREATER. That can only mean what we have is a sampling error (picking random start and stop dates) or basics of finance is not applicable (no free lunch) in what is likely the 2 largest markets in the world (US and European equity markets). My vote is the former.

IF the above is true then the question that comes up repeatedly to me, "Why does the US centric investor keep pitching the idea of it is less risky and that is why they choose only U.S. equity investing?" The two don't jive with me. If the U.S. centric investor said, "I do US only as I think it is safer place to invest and I accept less return due to that safety" then it makes sense. However, that is never the case in the argument.

Good luck.
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Re: If riskier than US, why doesn't international outperform?

Post by staythecourse »

Since this was based on my original post on several threads I hope I can help maybe reword it a bit. Hope okay with the OP of this thread.

The question is: If U.S. investing is considered safer then why don't the U.S. only investor EXPECT less return? Don't think I have ever seen any poster who is U.S. only investor ever state that opinion. IN fact, the reason they usually want to invest in U.S. only is that it has GREATER return (just the opposite) and consider international MORE risky.

Good luck.
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Re: If riskier than US, why doesn't international outperform?

Post by Alexa9 »

If you separate developed from emerging markets, it's a different discussion. Emerging markets are far riskier and may greatly outperform or underperform US. There are also political issues that make the US very friendly to investors and business. Developed markets likely perform similarly but may lag for these reasons. Many factors but a risk premium is no guarantee of anything just like small value, momentum, etc.
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Re: If riskier than US, why doesn't international outperform?

Post by Tycoon »

Because markets are driven by behavior, not fancy math formulas.
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Re: If riskier than US, why doesn't international outperform?

Post by Valuethinker »

samsdad wrote: Fri Nov 16, 2018 8:10 am In another thread on international investing, this question was asked but didn't gain any traction (as of yet). I think it's a great question, perhaps the question, and have my theories but would like others' views as well.
staythecourse wrote: Tue Nov 13, 2018 4:57 pm
samsdad wrote: Tue Nov 13, 2018 4:44 pm Mr. Bogle’s views on capitalism, entrepreneurship, work ethic, transparency, law, corruption, and currency risk are basically shared by me after not only considered reflection, but also from my own experience living overseas.
Not trying to cause another debate, but trying to understand here. Since you stated the above is so obvious then shouldn't the U.S. only investor returns be LESS then the one who invests in international? IF U.S. is obviously safer then shouldn't they be discounted? If not then one is saying they don't believe in the "no free lunch" thought process, no?

It is this issue that I don't understand from the U.S. only investor. It seems they all (maybe I'm wrong) state the above and BECAUSE of that obvious safety still EXPECT it to outperform, i.e. more return for less risk? That simply doesn't make sense to me.

No one has been able to coherently explain this one aspect to me.

Thanks.

Good luck.
You are confusing ex ante returns with ex post returns. These are probabilistic events, you cannot determine them sitting on Jan 1 1900 what the outcome will be 16 November 2018.

Ex ante (before the fact) is what you would expect. Ex post is what you actually got.

The world ran the model of a number of stock markets, starting in 1900, and ran it for 2017 years (and counting). That was *one* model run out of the infinity of possible answers. Note the picture would probably have looked quite different in 1990 - Japan would have been the all time winner.

In another model run, US & USSR fought a nuclear war over Cuba in 1962, and so the returns on the US stock market were truly lousy - the US was a devastated ruin.

All we can say is that based upon past experience, the likely volatility of the markets is X. Even that's not actually true, but it's a rough rule of thumb. If past returns have any predictive power on future returns (again experience is mixed) then we might be able to say something about likely returns. If valuation matters to future returns (it might) then we could make further assertions about likely returns.
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Re: If riskier than US, why doesn't international outperform?

Post by Walkure »

nisiprius wrote: Fri Nov 16, 2018 8:36 am Luck...
For another thing, over long periods of time, the performance of national stock markets has been so obviously driven by major events of world history, that unless you are confident you can predict revolutions and world wars, you just to give up. Over long periods of time, everything is obviously dominated economic good luck of the United States, and the economic bad luck of Europe, during World War I and II.
samsdad wrote: Tue Nov 13, 2018 4:44 pm Mr. Bogle’s views on capitalism, entrepreneurship, work ethic, transparency, law, corruption, and currency risk are basically shared by me after not only considered reflection, but also from my own experience living overseas.
It seems like the disparity in expectations arises from those who, in the Bogle spirit, believe that what you are calling "economic good luck" was not truly random but the inevitable and predictable result of US attitudes and legal conditions ex ante. I have a nagging suspicion that persons with higher risk aversion also have a more deterministic worldview, which primes for confirmation bias toward US exceptionalism. (i.e. exceptionalism per se requires not only that we did well ex post but that we did so necessarily for virtuous reasons, and therefore predictably.) Conversely someone who sees too many variables to predict with confidence is indeterminist. The determinist sees risk in terms of being on the wrong side of history (loss aversion), while the indeterminist defines it in terms of becoming irrelevant to the outcome (FOMO), which leads to different approaches.

A second issue is the confusion of defining "risk" via standard deviation, and then comparing the US half of the market to the ex-US half. If instead we compared US to All-world (incl US), I'm pretty sure the US alone would look "riskier" than the whole, even if it is not necessarily less volatile than the other half.
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Re: If riskier than US, why doesn't international outperform?

Post by columbia »

One of them carries an unrewarded risk and the other doesn’t - and that difference isn’t going away.
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Re: If riskier than US, why doesn't international outperform?

Post by White Coat Investor »

I expect reversion to the mean at some point. The good news is you can buy international stocks right now at 2006 prices.
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Re: If riskier than US, why doesn't international outperform?

Post by asif408 »

Here are some excerpts from a few books I think are useful to this discussion. First, from 'Against the Gods' by Peter Bernstein, speaks about emerging markets performance vs the S&P 500 in the early 1990s:
Or consider those 13 emerging markets I mentioned earlier. From the end of 1989 to February 1994, they were three times as volatile as the S&P 500, but an investor in the package of emerging markets had fewer losing months, was consistently wealthier, and, even after the sharp drop at the end of 1994, ended up three times richer than the investor in the S&P 500. Which was riskier, the S&P 500 or the emerging markets index?
Now, from the Four Pillars of Investing, 2010 Postcript, by William Bernstein:
Diversification works in the long run. That, of course, is not what you're hearing these, days, and for good reason.....During the most recent market turmoil (speaking about 2007-2009) there was simply no place to hide; all stocks got hammered, and the further investors strayed from the good old S&P 500, the more they lost.
Now, the punch line: consider how these asset classes fared over the full decade of the 2000s:

Jan. 2000-Dec. 2009
S&P 500: -9.10%
US large-cap value stocks: +27.62%
US small-cap stocks: +41.23%
US REITs: +170.86%
Int'l large-cap stocks: +16.97%
Int'l large-cap value stocks: +48.47%
Int'l small-cap stocks: +94.29%
Emerging Markets: +161.96%

During the past decade, the further you diversified away from a traditional portfolio of large-cap stocks, the better you did.
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Re: If riskier than US, why doesn't international outperform?

Post by longinvest »

Hints... Not to a complete answer, just to a partial one. But, stll a significant aspect of foreign investing.

Hint: Why, as a Canadian, don't I get the same returns as a U.S. domestic stocks investor (VTI ETF) when I invest into a currency-hedged identical investment (VUS ETF)? Why is my risk different?

Second hint: Investing into VTI directly (or into its VUN ETF wrapper) would still expose me to different returns and risks than a U.S. investor.

Third hint: The answer is in a post I've written in another thread: viewtopic.php?p=3901089#p3901089
Last edited by longinvest on Fri Nov 16, 2018 11:31 am, edited 2 times in total.
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Re: If riskier than US, why doesn't international outperform?

Post by JBTX »

samsdad wrote: Fri Nov 16, 2018 8:10 am In another thread on international investing, this question was asked but didn't gain any traction (as of yet). I think it's a great question, perhaps the question, and have my theories but would like others' views as well.
staythecourse wrote: Tue Nov 13, 2018 4:57 pm
samsdad wrote: Tue Nov 13, 2018 4:44 pm Mr. Bogle’s views on capitalism, entrepreneurship, work ethic, transparency, law, corruption, and currency risk are basically shared by me after not only considered reflection, but also from my own experience living overseas.
Not trying to cause another debate, but trying to understand here. Since you stated the above is so obvious then shouldn't the U.S. only investor returns be LESS then the one who invests in international? IF U.S. is obviously safer then shouldn't they be discounted? If not then one is saying they don't believe in the "no free lunch" thought process, no?

It is this issue that I don't understand from the U.S. only investor. It seems they all (maybe I'm wrong) state the above and BECAUSE of that obvious safety still EXPECT it to outperform, i.e. more return for less risk? That simply doesn't make sense to me.

No one has been able to coherently explain this one aspect to me.

Thanks.

Good luck.
A big part of whether the US overperforms or underperforms is the relationship of the US dollar to other world currencies. Depending when your starting point is you will get different answers.

https://www.macrotrends.net/1329/us-dol ... ical-chart

Currency risk is mostly unrewarded volatility, but in certain circumstances it could be of benefit. If the US economy were to falter relative to the rest of the world, typically when economies falter, your currency falls, and international investments benefit. To some degree international investments are a hedge against a scenario that happened to Japan.

Speaking of Japan, I am sure its terrible long term performance has hurt the international index. So it depends on whether you view that as an outlier, or just a normal part of any international portfolio. The argument it for being an outlier is that at one point it was close to 50% of total world market weight, so its fall disproportionately hurt the international index.
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Re: If riskier than US, why doesn't international outperform?

Post by TJSI »

The idea that taking more risk leads to greater return is one of most enduring fallacies of finance. Sometimes it is stated something like "investors demand greater return otherwise they would not take the added risk." Well you can demand all you want but that does not mean you are going to get.

TJSI
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Re: If riskier than US, why doesn't international outperform?

Post by willthrill81 »

TJSI wrote: Fri Nov 16, 2018 11:44 am The idea that taking more risk leads to greater return is one of most enduring fallacies of finance. Sometimes it is stated something like "investors demand greater return otherwise they would not take the added risk." Well you can demand all you want but that does not mean you are going to get.

TJSI
Plus, there are some risks investors can take on that are not compensated for at all in the long-term, such as currency risk.
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Re: If riskier than US, why doesn't international outperform?

Post by GAAP »

Walkure wrote: Fri Nov 16, 2018 10:27 am It seems like the disparity in expectations arises from those who, in the Bogle spirit, believe that what you are calling "economic good luck" was not truly random but the inevitable and predictable result of US attitudes and legal conditions ex ante. I have a nagging suspicion that persons with higher risk aversion also have a more deterministic worldview, which primes for confirmation bias toward US exceptionalism. (i.e. exceptionalism per se requires not only that we did well ex post but that we did so necessarily for virtuous reasons, and therefore predictably.) Conversely someone who sees too many variables to predict with confidence is indeterminist. The determinist sees risk in terms of being on the wrong side of history (loss aversion), while the indeterminist defines it in terms of becoming irrelevant to the outcome (FOMO), which leads to different approaches.
I think you've described the essence of these "debates" and also why nobody on either side is convinced to change their view...

I ran a really quick comparison of a 100% USA vs 50/50 on PortfolioVisualizer. As expected, the relative standard deviations varied depending upon the time interval chosen. 1986-1996 and 1996-2006 were in favor of the 50/50, 2006-2016 in favor of USA. The differences in standard deviation didn't necessarily also correspond to the differences in returns -- and would have been easily influenced by changing the endpoint dates.

I personally don't see the justification for the exceptionalism argument, others do.
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Re: If riskier than US, why doesn't international outperform?

Post by staythecourse »

Just curious if anyone on here would be ardent U.S. only investors if the returns would have been the opposite of international the last 20 years?

How much of all of this is purely behavioral. I am ALWAYS skeptical there isn't a behavioral issue with myself when I want to invest in something which just happens to be the higher producing asset class. Just curious if anyone else feels that who are all in on U.S. only?

Good luck.
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Re: If riskier than US, why doesn't international outperform?

Post by garlandwhizzer »

There is an inherent lack of predictability in the market. Mr. Market seems to enjoy frustrating those who develop theories and narratives to explain why it does what it does when it does, and to predict its future. In theory taking on increased risk is expected to produce increased reward because there is a risk/reward tradeoff. This is a totally convincing narrative that makes sense. It is clearly and demonstrably true for stocks versus high quality bonds over long time frames. It takes more than a convincing narrative that makes sense, however, to consistently produce results. Why wouldn't the risk/reward tradeoff be true for US versus INTL? Why in fact is there is there a factor, low volatility/bet against beta, that suggests the exact opposite, that taking on less risk/less volatility over long time frames actually paradoxically increases long term rewards? Answers that are offered to explain these paradoxes are IMO unconvincing. It seems to me the take home lesson is that our state of knowledge about the market is and always has been imperfect and theories that attempt to explain market action in a consistent way are just that, theories not laws. A large dose of humility seems the appropriate attitude when someone tells you in detail what going to happen in the market's future and why.

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Re: If riskier than US, why doesn't international outperform?

Post by willthrill81 »

garlandwhizzer wrote: Fri Nov 16, 2018 12:04 pmAnswers that are offered to explain these paradoxes are IMO unconvincing. It seems to me the take home lesson is that our state of knowledge about the market is and always has been imperfect and theories that attempt to explain market action in a consistent way are just that, theories not laws. A large dose of humility seems the appropriate attitude when someone tells you in detail what going to happen in the market's future and why.
I suspect that the market may be an application of the observer effect from physics: "simply observing a situation or phenomenon necessarily changes that phenomenon."

The notion that we can observe the market, create theories and hypotheses concerning it, and then test and implement those theories without the whole process impacting the market in some way seems false.
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Re: If riskier than US, why doesn't international outperform?

Post by WhiteMaxima »

US companies has a lot revenue from int'l market. If you won US company, you basically own the world. US companies are running more efficient than international counterpart, so we do see US equity outperform than intl. But as US equity valuation become too rich than intl, the tide will reverse. Now Int'l is more attractive in value than US. Time will tell.
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Re: If riskier than US, why doesn't international outperform?

Post by GAAP »

willthrill81 wrote: Fri Nov 16, 2018 12:10 pm The notion that we can observe the market, create theories and hypotheses concerning it, and then test and implement those theories without the whole process impacting the market in some way seems false.
I also find the notion that rational decisions made by individual investors necessarily means that the entire market is rational. After all, the people buying and selling in any transaction are both acting rationally simultaneously -- but for different reasons. That in turn means that the market is simply an instantaneous reflection of randomness, and not something that can be tested or predicted. The logical conclusion that follows is to index as broadly as possible across the entire market (and across asset types).
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Re: If riskier than US, why doesn't international outperform?

Post by willthrill81 »

GAAP wrote: Fri Nov 16, 2018 12:25 pm
willthrill81 wrote: Fri Nov 16, 2018 12:10 pm The notion that we can observe the market, create theories and hypotheses concerning it, and then test and implement those theories without the whole process impacting the market in some way seems false.
I also find the notion that rational decisions made by individual investors necessarily means that the entire market is rational. After all, the people buying and selling in any transaction are both acting rationally simultaneously -- but for different reasons. That in turn means that the market is simply an instantaneous reflection of randomness, and not something that can be tested or predicted. The logical conclusion that follows is to index as broadly as possible across the entire market (and across asset types).
But I also think it's worth noting that the biases of all of the investors in a market are always perfectly counter-balanced is completely false. I believe that there are times, especially when the market is very volatile, that the market as a whole may tilt toward a particular bias.
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Re: If riskier than US, why doesn't international outperform?

Post by GAAP »

willthrill81 wrote: Fri Nov 16, 2018 12:28 pm But I also think it's worth noting that the biases of all of the investors in a market are always perfectly counter-balanced is completely false. I believe that there are times, especially when the market is very volatile, that the market as a whole may tilt toward a particular bias.
And that is an excellent description of why we have market crashes and bubbles.
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Re: If riskier than US, why doesn't international outperform?

Post by ReformedSpender »

They've outperformed before and they'll outperform again (imo)

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Re: If riskier than US, why doesn't international outperform?

Post by dknightd »

One day it it might outperform. Who knows. That is why I diversify.
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Re: If riskier than US, why doesn't international outperform?

Post by asif408 »

staythecourse wrote: Fri Nov 16, 2018 12:01 pm Just curious if anyone on here would be ardent U.S. only investors if the returns would have been the opposite of international the last 20 years?

How much of all of this is purely behavioral. I am ALWAYS skeptical there isn't a behavioral issue with myself when I want to invest in something which just happens to be the higher producing asset class. Just curious if anyone else feels that who are all in on U.S. only?

Good luck.
What you are saying actually happened from the early 1970s to the early 1990s. It is highlighted in the 'Global Investing' book by Ibbotson and Brinson. The problem is that international investing wasn't common during that time frame, and there hasn't yet been a twenty year period since that time in which that has been the case when international indexes were easily investable. Of course a good chunk of the underperformance since 1990 was due to Japan (and, don't forget, a large part of the outperformance in the previous 20 years was also due to Japan).

I imagine if the international indices outperform in the next decade we may be able to look back and say there is a 20+ year period of outperformance. And I also imagine the tune would be different around here from many of those US only folks.
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Re: If riskier than US, why doesn't international outperform?

Post by AlohaJoe »

Walkure wrote: Fri Nov 16, 2018 10:27 am It seems like the disparity in expectations arises from those who, in the Bogle spirit, believe that what you are calling "economic good luck" was not truly random but the inevitable and predictable result of US attitudes and legal conditions ex ante.
But this can't be right either. If it was predictable then the market should have priced it accordingly.

I think the real answer is that such people don't believe markets are rational and believe that someone with guts & grit & conviction can easily beat the market by making obvious active management choices.
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Re: If riskier than US, why doesn't international outperform?

Post by longinvest »

Nobody commented on my earlier hints, so I'll be explicit.
longinvest wrote: Fri Nov 16, 2018 11:23 am Hints...
A security (stock or bond) doesn't carry the same returns for two investors, a domestic one and a foreign one.

Let me use Vanguard's Total Stock Market ETF (VTI) as an example. Most members of this site have part of their portfolio invested in this ETF or in a mutual fund version of it (VTSMX and VTSAX).

As a Canadian investor, VTI is a foreign ETF to me. I could invest directly into it, as most Canadian brokerages give direct access to the US stock market. But buying VTI would force me to convert my Canadian money into US dollars before making the transaction, and most brokerages charge a hefty fee (between 1% and 2%) for it on top of the buy/sell currency spread. Worse, not all discount brokerages support US dollar accounts. In a Canadian dollar account, any reinvested VTI distribution is converted to Canadian dollars and back to US dollars, with the 1% to 2% fee charged twice on top the the roundtrip spreads!

Instead of playing the currency game myself, I can use Vanguard Canada wrapper ETFs for VTI. There are two wrapper ETFs, with and without currency hedging:
  • U.S. Total Market Index ETF (CAD-hedged) (VUS)
  • U.S. Total Market Index ETF (VUN)
Vanguard Canada takes care of converting invested money into US dollars cost-effectively. It's simpler and also allows for proper Canadian paperwork issued by the Canadian wrapper ETFs. I forgot to tell about that, earlier: directly holding foreign securities comes with its own paperwork headache. The wrapper ETFs eliminate this.

A picture is worth a thousand words. Luckily, Portfolio VIsualizer includes Canadian market data. Here's a comparison of the three ETFs. Note that the chart displays the growth of each ETF in its home currency: US dollars for VTI and Canadian dollars for VUS and VUN.

Source: Portfolio Visualizer

blue: VTI (USD)
red: VUS (CAD) -- VTI wrapper with CAD-hedging
orange: VUN (CAD) -- VTI wrapper (no currency hedging)

Image

We see the impact of currency-hedging (VUS which has a similar trajectory to VTI but with a drag), and currency fluctuations (VUN which diverges from VTI's trajectory).

Canadian investors into the unhedged VUN ETF fared much better than US VTI investors! But, that's solely due to the fact that the US dollar gained in value relative to the Canadian dollar. The reverse situation happened in the past, where the Canadian dollar gained in value relative to the US dollar. This would cause VUN to fare much worse in CAD than VTI in USD.

Canadian investors into the currency-hedged VUS ETF didn't get VTI's full return; while VTI grew to $18,060, VUS only grew to $17,400 due to the hidden costs of foreign investing. That's ($7,400 / $8,060 - 1) = -8.2% of VTI's gains that were lost for Canadian investors.

What I am trying to explain is that VTI is both riskier to me than to a US investor, and its return is lower for me when currency hedged. It would be illogical for me to anticipate the higher risk of VTI to translate into a higher return. I can try my luck with an unhedged ETF, but it could easily backfire with no reason for me to be compensated for the higher risk.

In summary, international investing can diversify a portfolio, but it is riskier* and costlier than domestic investing. It wouldn't be logical to anticipate the higher risk to translate into a better performance.

* Where risk isn't measured by volatility.

Disclosure: I invest 25% of my portfolio into international stocks without currency hedging using the FTSE Global All Cap ex Canada Index ETF (VXC).
Last edited by longinvest on Sun Nov 18, 2018 9:45 am, edited 1 time in total.
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Re: If riskier than US, why doesn't international outperform?

Post by 2015 »

garlandwhizzer wrote: Fri Nov 16, 2018 12:04 pm There is an inherent lack of predictability in the market. Mr. Market seems to enjoy frustrating those who develop theories and narratives to explain why it does what it does when it does, and to predict its future. In theory taking on increased risk is expected to produce increased reward because there is a risk/reward tradeoff. This is a totally convincing narrative that makes sense. It is clearly and demonstrably true for stocks versus high quality bonds over long time frames. It takes more than a convincing narrative that makes sense, however, to consistently produce results. Why wouldn't the risk/reward tradeoff be true for US versus INTL? Why in fact is there is there a factor, low volatility/bet against beta, that suggests the exact opposite, that taking on less risk/less volatility over long time frames actually paradoxically increases long term rewards? Answers that are offered to explain these paradoxes are IMO unconvincing. It seems to me the take home lesson is that our state of knowledge about the market is and always has been imperfect and theories that attempt to explain market action in a consistent way are just that, theories not laws. A large dose of humility seems the appropriate attitude when someone tells you in detail what going to happen in the market's future and why.

Garland Whizzer
An excellent explanation, elegant in its simplicity and straightforwardness.
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Re: If riskier than US, why doesn't international outperform?

Post by fennewaldaj »

As others have stated currency fluctuation one risk in foreign investing that you should definitely not expect compensation. One could argue that some currency diversification this reduces deep risk but it will certainly increase standard deviation. International investing is a bit more expensive as well which is a bit of a drag on returns. So one might expect that the expected returns are a bit lower with a bit higher standard deviation. Political risk is likely priced in to some degree. Things like the risk of market closure are also not symmetrical. If the US market was ever fully closed (like Russia and China last century) it would likely mean that US citizens would lose all there foreign assets as well.
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Re: If riskier than US, why doesn't international outperform?

Post by privatefarmer »

garlandwhizzer wrote: Fri Nov 16, 2018 12:04 pm There is an inherent lack of predictability in the market. Mr. Market seems to enjoy frustrating those who develop theories and narratives to explain why it does what it does when it does, and to predict its future. In theory taking on increased risk is expected to produce increased reward because there is a risk/reward tradeoff. This is a totally convincing narrative that makes sense. It is clearly and demonstrably true for stocks versus high quality bonds over long time frames. It takes more than a convincing narrative that makes sense, however, to consistently produce results. Why wouldn't the risk/reward tradeoff be true for US versus INTL? Why in fact is there is there a factor, low volatility/bet against beta, that suggests the exact opposite, that taking on less risk/less volatility over long time frames actually paradoxically increases long term rewards? Answers that are offered to explain these paradoxes are IMO unconvincing. It seems to me the take home lesson is that our state of knowledge about the market is and always has been imperfect and theories that attempt to explain market action in a consistent way are just that, theories not laws. A large dose of humility seems the appropriate attitude when someone tells you in detail what going to happen in the market's future and why.

Garland Whizzer
Garland - I want to personally thank you for your insightful posts. I used to be solidly in the "factor tilting/DFA/SCV" camp but have recently come back around to owning TSM as cheaply as possible. This last post sums it up best - the market is still dumbfounding to us and theory after theory do not make law. I have long bought into the idea of "higher risk = higher long-term return" but I too am starting to see the cracks in that theory. I suppose all one can do is own a low a cost portfolio, that is well diversified, and hope for the best.
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Re: If riskier than US, why doesn't international outperform?

Post by privatefarmer »

WhiteMaxima wrote: Fri Nov 16, 2018 12:17 pm US companies has a lot revenue from int'l market. If you won US company, you basically own the world. US companies are running more efficient than international counterpart, so we do see US equity outperform than intl. But as US equity valuation become too rich than intl, the tide will reverse. Now Int'l is more attractive in value than US. Time will tell.
yeah and the problem there is that everything is in the PAST tense. US HAS been more "efficient" than intl, the US HAS been more favorable to corporations/capitalism, etc. but nobody knows what the future has in store. It is entirely possible that the US could lag the rest of the developed world in free capitalism/corporate growth and one is wise to not tilt one way or the other.
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Re: If riskier than US, why doesn't international outperform?

Post by visualguy »

privatefarmer wrote: Sat Nov 17, 2018 12:54 am
WhiteMaxima wrote: Fri Nov 16, 2018 12:17 pm US companies has a lot revenue from int'l market. If you won US company, you basically own the world. US companies are running more efficient than international counterpart, so we do see US equity outperform than intl. But as US equity valuation become too rich than intl, the tide will reverse. Now Int'l is more attractive in value than US. Time will tell.
yeah and the problem there is that everything is in the PAST tense. US HAS been more "efficient" than intl, the US HAS been more favorable to corporations/capitalism, etc. but nobody knows what the future has in store. It is entirely possible that the US could lag the rest of the developed world in free capitalism/corporate growth and one is wise to not tilt one way or the other.
It's possible, but these are big changes that don't happen quickly. My assessment has been that such radical changes are extremely unlikely to happen quickly enough to benefit me as an index investor within the limited time frame that's relevant to me. I'll need the money long before such changes (if they happen) could pay off for me.
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Re: If riskier than US, why doesn't international outperform?

Post by indexonlyplease »

My question would be is why has Vanguard made such a decision on the target dated funds and the lifestyle funds. They have made a commitment to invest over 30% percent of the stocks in international?

So, I question does anyone really know more than the people at Vanguard? Not sure what other target dated fund have in international.

Would someone be better invested in the total stock market fund only for the young investor? (my 22 yr old son)

Is investing in international a tilt like investing in small value? You just don't know what the returns will be.

If one decided to invest in large US companies only like the total stock market, is that really bad. Maybe this will go on for another 50 years of good returns. Large companies fund have done well so why not just stay will them.
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Re: If riskier than US, why doesn't international outperform?

Post by petulant »

longinvest wrote: Fri Nov 16, 2018 10:29 pm Nobody commented on my earlier hints, so I'll be explicit.
longinvest wrote: Fri Nov 16, 2018 11:23 am Hints...
A security (stock or bond) doesn't carry the same returns for two investors, a domestic one and a foreign one.

Let me use Vanguard's Total Stock Market ETF (VTI) as an example. Most members of this site have part of their portfolio invested in this ETF or in a mutual fund version of it (VTSMX and VTSAX).

As a Canadian investor, VTI is a foreign ETF to me. I could invest directly into it, as most Canadian brokerages give direct access to the US stock market. But buying VTI would force me to convert my Canadian money into US dollars before making the transaction, and most brokerages charge a hefty fee (between 1% and 2%) for it on top of the buy/sell currency spread. Worse, not all discount brokerages support US dollar accounts. In a Canadian dollar account, any reinvested VTI distribution is converted to Canadian dollars and back to US dollars, with the 1% to 2% fee charged twice on top the the roundtrip spreads!

Instead of playing the currency game myself, I can use Vanguard Canada wrapper ETFs for VTI. There are two wrapper ETFs, with and without currency hedging:
  • U.S. Total Market Index ETF (CAD-hedged) (VUS)
  • U.S. Total Market Index ETF (VUN)
Vanguard Canada takes care of converting invested money into US dollars cost-effectively. It's simpler and also allows for proper Canadian paperwork issued by the Canadian wrapper ETFs. I forgot to tell about that, earlier: directly holding foreign securities comes with its own paperwork headache. The wrapper ETFs eliminate this.

A picture is worth a thousand words. Luckily, Portfolio VIsualizer includes Canadian market data. Here's a comparison of the three ETFs. Note that the chart displays the growth of each ETF in its home currency: US dollars for VTI and Canadian dollars for VUS and VUN.

Source: Portfolio Visualizer

blue: VTI (USD)
red: VUS (CAD) -- VTI wrapper with CAD-hedging
orange: VUN (CAD) -- VTI wrapper (no currency hedging)

Image

We see the impact of currency-hedging (VUS which has a similar trajectory to VTI but with a drag), and currency fluctuations (VUN which diverges from VTI's trajectory).

Canadian investors into the unhedged VUN ETF fared much better than US VTI investors! But, that's solely due to the fact that the US dollar gained in value relative to the Canadian dollar. The reverse situation happened in the past, where the Canadian dollar gained in value relative to the US dollar. This would cause VUN to fare much worse in CAD than VTI in USD.

Canadian investors into the currency-hedged VUS ETF didn't get VTI's full return; while VTI grew to $18,060, VUS only grew to $17,400 due to the hidden costs of foreign investing. That's ($7,400 / $8,060 - 1) = -8.2% of VTI's gains that were lost for Canadian investors.

What I am trying to explain is that VTI is both riskier to me than to a US investor, and its return is lower for me when currency hedged. It would be illogical for me to anticipate the higher risk of VTI to translate into a higher return. I can try my luck with an unhedged ETF, but it could easily backfire with no reason for me to be compensated for the higher risk.

In summary, international investing can diversify a portfolio, but it is riskier* and costlier than domestic investing. It wouldn't be logical to anticipate the higher risk to translate into a better performance.

* Where risk isn't measured by volatility.

Disclosure: I invest 25% of my portfolio into international stocks without currency hedging using the FTSE Global All Cap ex Canada Index ETF (VXC).
Exactly right. Another way to put it is that the risk and return characteristics of an asset aren't experienced the same by all investors--sometimes even in the same country. We have to have a broader view of risk than just volatility (though volatility is very important). Risks could be behavioral (triggered by volatility or FOMO), sequence of returns (volatility driven), terminal wealth dispersion, or even just the failure to meet needs period. Investors with different incomes, assets, stages of life, and temperament will experience these risks differently.

International investing triggers these risks differently from domestic investing by decoupling the currency of the investment from the currency in which an investor meets needs. (That is not to say that's the only characteristic of international investing). The addition of currency increases volatility and affects the risk of failing to meet needs. Domestic investors who feel particularly exposed to volatility-driven risks (perhaps early stages of retirement) and need (perhaps a smaller portfolio) may believe it would be safer to adopt home bias. That doesn't mean the international equities have higher risks and returns for everybody; it means they have a specific risk the domestic investor doesn't want to take on because of their own position. The currency example provided in longinvest's charts illustrates the opposite effect, where another investor may benefit from international diversification thanks to currency shifts.

A large number of domestic investors taking the home bias position may not destabilize the marketwide volatility/return trade-off as long as other market participants can trade around the home bias investors. Further, home bias investing is common across the world, meaning any effect may be repeated across markets. (Canada, Australia, etc. all have high home bias.) I believe that's how you can get a situation where it is rational for some investors to adopt home bias, yet volatility/return trade-offs are not materially changed.
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Re: If riskier than US, why doesn't international outperform?

Post by rkhusky »

privatefarmer wrote: Sat Nov 17, 2018 12:52 am Garland - I want to personally thank you for your insightful posts. I used to be solidly in the "factor tilting/DFA/SCV" camp but have recently come back around to owning TSM as cheaply as possible. This last post sums it up best - the market is still dumbfounding to us and theory after theory do not make law. I have long bought into the idea of "higher risk = higher long-term return" but I too am starting to see the cracks in that theory. I suppose all one can do is own a low a cost portfolio, that is well diversified, and hope for the best.
Theories in science are well-established and well-supported broad descriptions of nature. Laws in science are specific relationships that hold to a high degree under specific conditions. Stock investing consists of rules of thumb and approximate empirical relationships, none of which rise to the level of theories or laws.
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Re: If riskier than US, why doesn't international outperform?

Post by jeffyscott »

petulant wrote: Sat Nov 17, 2018 7:10 amInternational investing triggers these risks differently from domestic investing by decoupling the currency of the investment from the currency in which an investor meets needs.
I'm not so sure that the only currency that I should care about is US dollars. If I buy foreign products, will I not be affected by the value of those other currencies?

Many things we purchase come from elsewhere, I might buy a car designed in S. Korea, assembled in Mexico, with parts from who knows where, for example. I have noticed that a few things that I buy come from China. Even some food that we buy comes from other countries.
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Re: If riskier than US, why doesn't international outperform?

Post by Mako52 »

Successful international investing requires a serious understanding of what is going on in the economy of that country, IMHO. You can't get that just by reading The Economist or WSJ. You need to be there frequently and/or live there. See all the investors who jumped into BRICs. Or all the foreign investors who jumped into the US market ca. 1999-2000.

As a US citizen and resident I have a better feel for what is going on in our markets than I would investing in France or Belize (for example). That allows me to make more informed decisions.
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Re: If riskier than US, why doesn't international outperform?

Post by runner540 »

Mako52 wrote: Sat Nov 17, 2018 9:16 am Successful international investing requires a serious understanding of what is going on in the economy of that country, IMHO. You can't get that just by reading The Economist or WSJ. You need to be there frequently and/or live there. See all the investors who jumped into BRICs. Or all the foreign investors who jumped into the US market ca. 1999-2000.

As a US citizen and resident I have a better feel for what is going on in our markets than I would investing in France or Belize (for example). That allows me to make more informed decisions.
Can you give an example of what "informed decisions" means with regard to your investing? Are you picking specific US companies or sectors based on your local knowledge? Or are you market timing in the US index?
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Re: If riskier than US, why doesn't international outperform?

Post by petulant »

jeffyscott wrote: Sat Nov 17, 2018 8:32 am
petulant wrote: Sat Nov 17, 2018 7:10 amInternational investing triggers these risks differently from domestic investing by decoupling the currency of the investment from the currency in which an investor meets needs.
I'm not so sure that the only currency that I should care about is US dollars. If I buy foreign products, will I not be affected by the value of those other currencies?

Many things we purchase come from elsewhere, I might buy a car designed in S. Korea, assembled in Mexico, with parts from who knows where, for example. I have noticed that a few things that I buy come from China. Even some food that we buy comes from other countries.
That's something to think about. However, imports are only 15% of overall U.S. GDP, and net imports are less than 5%.
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Re: If riskier than US, why doesn't international outperform?

Post by stan1 »

indexonlyplease wrote: Sat Nov 17, 2018 6:57 am My question would be is why has Vanguard made such a decision on the target dated funds and the lifestyle funds. They have made a commitment to invest over 30% percent of the stocks in international?

So, I question does anyone really know more than the people at Vanguard? Not sure what other target dated fund have in international.

Would someone be better invested in the total stock market fund only for the young investor? (my 22 yr old son)

Is investing in international a tilt like investing in small value? You just don't know what the returns will be.

If one decided to invest in large US companies only like the total stock market, is that really bad. Maybe this will go on for another 50 years of good returns. Large companies fund have done well so why not just stay will them.
Some great questions that you'll get a lot of opinions on. I'll give mine because I think its important that people have a variety of viewpoints to think through this.

Vanguard international: I'll offer multiple reasons. There's plenty of theory supporting international allocation. Many advisors and customers want it. Unlike 20 years ago its not expensive to invest in international but today it is not.

Age of investor: No one knows what the future will bring. Because of that some people think the future will look a lot like the past and others think it might look very different. For someone in their 70s or 80s the odds are probably more likely the rest of their lives will look like the past. Your son in his 20s may live 100 more years. There's greater likelihood of change during the remainder of his life simply because there's more time for change to happen. 100 years ago some people other than the Amish still rode horses to work.

Is investing in international a tilt? Actually I'd say choosing NOT to invest in the total market including international is a tilt. Logically if you own stock in Apple, Chase, Exxon-Mobil, and Ford why not also Samsung, HSBC, Shell, and Toyota? Is there a basis to think the American companies will perform better than the international companies? Decision to underweight international relative to the world stock market is similar analysis to the decision to overweight a factor. Other will have different opinions on this.

Is investing only in domestic total stock market bad? The most important decision in asset allocation and managing risk is still the percentage of equities vs fixed income. Will an investor fail if they choose only Total Stock Market? Probably not. Can a young investor choose to add international at a later date? Sure.

I have invested 2/3 of equity in domestic and 1/3 in international for years now. I did not do market weight because I wanted lower exposure to currency risk, but I also did not want zero exposure to international because I see people all around me using Samsung phones and driving German cars. I do think some of the recent threads have some people looking for facts and anecdotal quotes to support a decision they've already made based on past performance or personal reasons. I try to keep politics, religion, and social welfare issues out of my friendships and my investments but I do acknowledge its getting harder to do that right now. When I don't know what to do I try to stay flexible and not choose all or nothing positions.
Last edited by stan1 on Sat Nov 17, 2018 10:01 am, edited 2 times in total.
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Re: If riskier than US, why doesn't international outperform?

Post by Mako52 »

runner540 wrote: Sat Nov 17, 2018 9:19 am
Mako52 wrote: Sat Nov 17, 2018 9:16 am Successful international investing requires a serious understanding of what is going on in the economy of that country, IMHO. You can't get that just by reading The Economist or WSJ. You need to be there frequently and/or live there. See all the investors who jumped into BRICs. Or all the foreign investors who jumped into the US market ca. 1999-2000.

As a US citizen and resident I have a better feel for what is going on in our markets than I would investing in France or Belize (for example). That allows me to make more informed decisions.
Can you give an example of what "informed decisions" means with regard to your investing? Are you picking specific US companies or sectors based on your local knowledge? Or are you market timing in the US index?
Looking at specific US companies. For example:
Shake Shack (SHAK) .....every time I come here, it's packed. Why isn't their stock going up? 3 months later the stock goes up.
ULTA, TJ Maxx (TJX), etc. My wife and her friends have been shopping here for years. Why didn't I buy the stock?
Invisalign (ALGN)....a game-changing orthodontic treatment. (which, in fairness, took a beating recently)
Someone without local market knowledge won't pick up on opportunities like that.
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Re: If riskier than US, why doesn't international outperform?

Post by stemikger »

I guess Jack was onto something. I don't hold international, however, I advised my 23 year old daughter to simply put it all the Vanguard Target Date Fund which was one of her 401k options. She has many years to invest, so I don't know what the future will look like that far out, so for her I think it is better to diversify as much as possible.

I'm 54 and my wife is 58 and I will stick with the Balanced Index Fund until judgment day and so far not adding international has worked out handsomely.
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Re: If riskier than US, why doesn't international outperform?

Post by smectym »

indexonlyplease wrote: Sat Nov 17, 2018 6:57 am My question would be is why has Vanguard made such a decision on the target dated funds and the lifestyle funds. They have made a commitment to invest over 30% percent of the stocks in international?

So, I question does anyone really know more than the people at Vanguard? Not sure what other target dated fund have in international.

Would someone be better invested in the total stock market fund only for the young investor? (my 22 yr old son)

Is investing in international a tilt like investing in small value? You just don't know what the returns will be.

If one decided to invest in large US companies only like the total stock market, is that really bad. Maybe this will go on for another 50 years of good returns. Large companies fund have done well so why not just stay will them.
Nobody knows more than the peopie at Vanguard, but Vanguard’s decision to herd its investors like cattle into large international stock allocations has been handled poorly.

The decisionmaking process prior to the sudden shift was opaque. The big announcement didn’t explain “why now”—had Vanguard been “wrong all along” earlier in not requiring such a large international tilt, or had conditions changed—triggering a tectonic “market timing” event? Vanguard has been dogmatic in refusing to allow VPAS clients to opt out, and the sustained underperformance of int’l has damaged many investor portfolios.

Vanguard’s dogmatism is based on little more than truism and cliche: more diversification is better; international equities are
x % of the global economy, ergo investors must allocate x % of their portfolios to international equities. Maybe. An interesting idea; might have merit. Let investors think about it, weigh opposing views, and make up their own minds—rather than adopt a “party line” and try to jam it down their investors’ throats.

Smectym
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