Justifying Non World Market Cap

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era00100
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Justifying Non World Market Cap

Post by era00100 » Fri Nov 01, 2019 7:11 pm

Most Bogleheads (generally) use a find like VTSAX for the US market, which follows market cap. Market cap is seen as a great passive way to select a portfolio of US stocks.

However, it seems like there is less consistency with Bogleheads when it comes to the world market cap.

The current Vanguard world fund has 55% US, and 45% ex-US. Most Bogleheads it seems use more than 55% US cap. The arguments Iv seen (which I do not doubt) are things like the US is the best environment for investing and business building, better regulations, and other similar arguments.

While these could be true, in theory, couldn’t the market (i.e. market cap) decide these weights and ultimately the weights from a fund like the Vanguard World Fund would be appropriate?

I’m curious about arguments for side stepping market cap weighting when it comes to US vs International stocks.

Eric

stan1
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Re: Justifying Non World Market Cap

Post by stan1 » Fri Nov 01, 2019 7:16 pm

Topic has been discussed exhaustively. It's a personal decision. That decision can be based on logic, flawed logic, or emotion (and combinations of those).

Pick something and stick with it. It likely won't make too much of a difference.

longinvest
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Re: Justifying Non World Market Cap

Post by longinvest » Fri Nov 01, 2019 7:24 pm

Here's an interesting Vanguard article:
The role of home bias in global asset allocation decisions.
Bogleheads investment philosophy | single-ETF balanced portfolio (VBAL) | VPW accumulation

retired@50
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Re: Justifying Non World Market Cap

Post by retired@50 » Fri Nov 01, 2019 7:28 pm

era00100 wrote:
Fri Nov 01, 2019 7:11 pm
Most Bogleheads (generally) use a find like VTSAX for the US market, which follows market cap. Market cap is seen as a great passive way to select a portfolio of US stocks.

However, it seems like there is less consistency with Bogleheads when it comes to the world market cap. I'd agree.

The current Vanguard world fund has 55% US, and 45% ex-US. Most Bogleheads it seems use more than 55% US cap. The arguments I've seen (which I do not doubt) are things like the US is the best environment for investing and business building, better regulations, and other similar arguments.

While these could be true, in theory, couldn’t the market (i.e. market cap) decide these weights and ultimately the weights from a fund like the Vanguard World Fund would be appropriate? They could, but this will only be known in hindsight.

I’m curious about arguments for side stepping market cap weighting when it comes to US vs International stocks.

Eric
Another argument that you didn't mention (at least not explicitly) is the home bias, which most investors face, even if they live in Germany, or Peru... For U.S. investors, the vast majority of them will need to spend from their portfolios in U.S. dollars, not euros or yen or any other currency. So, to me it makes sense to lean toward U.S. investments, either bonds or stocks. For what it's worth, I'm between 20 and 25% in International stocks and bonds.

Regards,

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era00100
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Re: Justifying Non World Market Cap

Post by era00100 » Fri Nov 01, 2019 7:43 pm


Another argument that you didn't mention (at least not explicitly) is the home bias, which most investors face, even if they live in Germany, or Peru... For U.S. investors, the vast majority of them will need to spend from their portfolios in U.S. dollars, not euros or yen or any other currency. So, to me it makes sense to lean toward U.S. investments, either bonds or stocks. For what it's worth, I'm between 20 and 25% in International stocks and bonds.

Regards,
The currency argument does make the most sense. But wouldn’t the international stock prices change if the value of their currency changes? Also, maybe it could be a good idea to diversify across currencies, as the dollar isn’t necessarily safe either?

anon_investor
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Re: Justifying Non World Market Cap

Post by anon_investor » Fri Nov 01, 2019 7:55 pm

stan1 wrote:
Fri Nov 01, 2019 7:16 pm
Topic has been discussed exhaustively. It's a personal decision. That decision can be based on logic, flawed logic, or emotion (and combinations of those).

Pick something and stick with it. It likely won't make too much of a difference.
+1.

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Re: Justifying Non World Market Cap

Post by willthrill81 » Fri Nov 01, 2019 8:10 pm

stan1 wrote:
Fri Nov 01, 2019 7:16 pm
Topic has been discussed exhaustively. It's a personal decision. That decision can be based on logic, flawed logic, or emotion (and combinations of those).

Pick something and stick with it. It likely won't make too much of a difference.
:thumbsup
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Re: Justifying Non World Market Cap

Post by columbia » Fri Nov 01, 2019 8:56 pm

Justify is a pretty loaded word, but folks should invest in what is comfortable for them.

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Re: Justifying Non World Market Cap

Post by arcticpineapplecorp. » Fri Nov 01, 2019 9:29 pm

Vanguard's target date funds used to have 30% international stock and 70% U.S. stock until a few years ago when they decided to increase the international stock portion to 40%. That's still not market cap is it (if international should be 45%)? Yet nobody would argue the target date retirement fund is a bad choice for one's core retirement portfolio.

the "justification" for these percentages Vanguard uses in their target date portfolios comes from here:

https://www.vanguard.com/pdf/ISGGEB.pdf

so at least it's research based. This paper's been updated over time and it used to be that 30% international stock was the sweet spot for reduced volatility but now it's 40%.

full disclosure : I'm 31% international right now. I plan on keeping it at around 30% but if it were to float as high as 40% it would not concern me.
"May you live as long as you want and never want as long as you live" -- Irish Blessing | "Invest we must" -- Jack Bogle

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Re: Justifying Non World Market Cap

Post by 305pelusa » Fri Nov 01, 2019 9:35 pm

era00100 wrote:
Fri Nov 01, 2019 7:43 pm

Another argument that you didn't mention (at least not explicitly) is the home bias, which most investors face, even if they live in Germany, or Peru... For U.S. investors, the vast majority of them will need to spend from their portfolios in U.S. dollars, not euros or yen or any other currency. So, to me it makes sense to lean toward U.S. investments, either bonds or stocks. For what it's worth, I'm between 20 and 25% in International stocks and bonds.

Regards,
The currency argument does make the most sense. But wouldn’t the international stock prices change if the value of their currency changes? Also, maybe it could be a good idea to diversify across currencies, as the dollar isn’t necessarily safe either?
The currency argument actually makes no sense. It's one of those things that sound correct ("if you spend in dollars then your investments should be in dollars") but there's no actual logic behind it.

Here's two "arguments" I've heard:
1) If there's US inflation, then your US equities, a claim on a real asset, will go up too. This is true over long terms. It's also true of international equities where, thanks to the more favorable exchange rate in the presence of US inflation, would be, if anything, better here.
2) Currencies don't have real returns so don't take on foreign currency risk. Foreign currency risk being that a country will suffer high inflation, its currency will depreciate, and your holdings in that currency will be worth less. I guess these people believe there's no domestic currency risk then and that the dollar is forever stable. Although you already realize this is wrong; you astutely notice that there's no real return on holding dollars either, so might as well diversify across other currencies. That way the only inflation that could really affect your retirement would be a global inflation (much less likely that any one country!).

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Re: Justifying Non World Market Cap

Post by rascott » Fri Nov 01, 2019 10:04 pm

305pelusa wrote:
Fri Nov 01, 2019 9:35 pm
era00100 wrote:
Fri Nov 01, 2019 7:43 pm

Another argument that you didn't mention (at least not explicitly) is the home bias, which most investors face, even if they live in Germany, or Peru... For U.S. investors, the vast majority of them will need to spend from their portfolios in U.S. dollars, not euros or yen or any other currency. So, to me it makes sense to lean toward U.S. investments, either bonds or stocks. For what it's worth, I'm between 20 and 25% in International stocks and bonds.

Regards,
The currency argument does make the most sense. But wouldn’t the international stock prices change if the value of their currency changes? Also, maybe it could be a good idea to diversify across currencies, as the dollar isn’t necessarily safe either?
The currency argument actually makes no sense. It's one of those things that sound correct ("if you spend in dollars then your investments should be in dollars") but there's no actual logic behind it.

Here's two "arguments" I've heard:
1) If there's US inflation, then your US equities, a claim on a real asset, will go up too. This is true over long terms. It's also true of international equities where, thanks to the more favorable exchange rate in the presence of US inflation, would be, if anything, better here.
2) Currencies don't have real returns so don't take on foreign currency risk. Foreign currency risk being that a country will suffer high inflation, its currency will depreciate, and your holdings in that currency will be worth less. I guess these people believe there's no domestic currency risk then and that the dollar is forever stable. Although you already realize this is wrong; you astutely notice that there's no real return on holding dollars either, so might as well diversify across other currencies. That way the only inflation that could really affect your retirement would be a global inflation (much less likely that any one country!).

Seeing the currency issue aside..... if one plans to live in the US for the rest of their life, like most will..... and say the US economy outperforms going forward over the next 30 years..... doesn't a global investor risk "falling behind" most of the rest of the country that is heavily home biased towards US markets?

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305pelusa
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Re: Justifying Non World Market Cap

Post by 305pelusa » Fri Nov 01, 2019 10:17 pm

rascott wrote:
Fri Nov 01, 2019 10:04 pm
305pelusa wrote:
Fri Nov 01, 2019 9:35 pm
era00100 wrote:
Fri Nov 01, 2019 7:43 pm

Another argument that you didn't mention (at least not explicitly) is the home bias, which most investors face, even if they live in Germany, or Peru... For U.S. investors, the vast majority of them will need to spend from their portfolios in U.S. dollars, not euros or yen or any other currency. So, to me it makes sense to lean toward U.S. investments, either bonds or stocks. For what it's worth, I'm between 20 and 25% in International stocks and bonds.

Regards,
The currency argument does make the most sense. But wouldn’t the international stock prices change if the value of their currency changes? Also, maybe it could be a good idea to diversify across currencies, as the dollar isn’t necessarily safe either?
The currency argument actually makes no sense. It's one of those things that sound correct ("if you spend in dollars then your investments should be in dollars") but there's no actual logic behind it.

Here's two "arguments" I've heard:
1) If there's US inflation, then your US equities, a claim on a real asset, will go up too. This is true over long terms. It's also true of international equities where, thanks to the more favorable exchange rate in the presence of US inflation, would be, if anything, better here.
2) Currencies don't have real returns so don't take on foreign currency risk. Foreign currency risk being that a country will suffer high inflation, its currency will depreciate, and your holdings in that currency will be worth less. I guess these people believe there's no domestic currency risk then and that the dollar is forever stable. Although you already realize this is wrong; you astutely notice that there's no real return on holding dollars either, so might as well diversify across other currencies. That way the only inflation that could really affect your retirement would be a global inflation (much less likely that any one country!).

Seeing the currency issue aside..... if one plans to live in the US for the rest of their life, like most will..... and say the US economy outperforms going forward over the next 30 years..... doesn't a global investor risk "falling behind" their neighbors that are heavily home biased towards US markets?
That's a different argument from "if you'll retire in dollars, keep your investments in dollars". Your argument is "keep the currency of your investments the same as the currency of your friends' investments".

I had never heard that one. The idea that I want to make sure I keep up with my neighbors in terms of wealth (and don't care to lose purchasing power if they do too) does not resonate with me much. But I suppose it might to some others.

BTW, most of my friends invest in globally diversified index funds so I personally get to have my cake and eat it too.

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Re: Justifying Non World Market Cap

Post by Dude2 » Fri Nov 01, 2019 10:19 pm

In the past it was significantly more expensive to invest internationally. To a large degree this drove the decision. This article lays out some factors. 10 Hidden Costs of Investing Overseas

In an ideal, theoretical world, global market cap makes sense. Otherwise we are back to the arguments concerning efficient markets. If you believe that all of the various factors are priced in, then you should have no problem with global market cap. On the other hand, how is it even possible that the prices factor in everything relative to you? There are 7 billion "you's" out there, how can the prices factor in everything for everybody?

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Re: Justifying Non World Market Cap

Post by rascott » Fri Nov 01, 2019 11:31 pm

305pelusa wrote:
Fri Nov 01, 2019 10:17 pm
rascott wrote:
Fri Nov 01, 2019 10:04 pm
305pelusa wrote:
Fri Nov 01, 2019 9:35 pm
era00100 wrote:
Fri Nov 01, 2019 7:43 pm

Another argument that you didn't mention (at least not explicitly) is the home bias, which most investors face, even if they live in Germany, or Peru... For U.S. investors, the vast majority of them will need to spend from their portfolios in U.S. dollars, not euros or yen or any other currency. So, to me it makes sense to lean toward U.S. investments, either bonds or stocks. For what it's worth, I'm between 20 and 25% in International stocks and bonds.

Regards,
The currency argument does make the most sense. But wouldn’t the international stock prices change if the value of their currency changes? Also, maybe it could be a good idea to diversify across currencies, as the dollar isn’t necessarily safe either?
The currency argument actually makes no sense. It's one of those things that sound correct ("if you spend in dollars then your investments should be in dollars") but there's no actual logic behind it.

Here's two "arguments" I've heard:
1) If there's US inflation, then your US equities, a claim on a real asset, will go up too. This is true over long terms. It's also true of international equities where, thanks to the more favorable exchange rate in the presence of US inflation, would be, if anything, better here.
2) Currencies don't have real returns so don't take on foreign currency risk. Foreign currency risk being that a country will suffer high inflation, its currency will depreciate, and your holdings in that currency will be worth less. I guess these people believe there's no domestic currency risk then and that the dollar is forever stable. Although you already realize this is wrong; you astutely notice that there's no real return on holding dollars either, so might as well diversify across other currencies. That way the only inflation that could really affect your retirement would be a global inflation (much less likely that any one country!).

Seeing the currency issue aside..... if one plans to live in the US for the rest of their life, like most will..... and say the US economy outperforms going forward over the next 30 years..... doesn't a global investor risk "falling behind" their neighbors that are heavily home biased towards US markets?
That's a different argument from "if you'll retire in dollars, keep your investments in dollars". Your argument is "keep the currency of your investments the same as the currency of your friends' investments".

I had never heard that one. The idea that I want to make sure I keep up with my neighbors in terms of wealth (and don't care to lose purchasing power if they do too) does not resonate with me much. But I suppose it might to some others.

BTW, most of my friends invest in globally diversified index funds so I personally get to have my cake and eat it too.

I don't really mean one's actual neighbors, just in the macro sense.

TropikThunder
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Re: Justifying Non World Market Cap

Post by TropikThunder » Sat Nov 02, 2019 12:14 am

Oh good, an international stock thread that will be filled by the same people making the same comments on each side of the issue. Can't wait .... :P

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Re: Justifying Non World Market Cap

Post by JBTX » Sat Nov 02, 2019 12:43 am

era00100 wrote:
Fri Nov 01, 2019 7:43 pm

Another argument that you didn't mention (at least not explicitly) is the home bias, which most investors face, even if they live in Germany, or Peru... For U.S. investors, the vast majority of them will need to spend from their portfolios in U.S. dollars, not euros or yen or any other currency. So, to me it makes sense to lean toward U.S. investments, either bonds or stocks. For what it's worth, I'm between 20 and 25% in International stocks and bonds.

Regards,
The currency argument does make the most sense. But wouldn’t the international stock prices change if the value of their currency changes? Also, maybe it could be a good idea to diversify across currencies, as the dollar isn’t necessarily safe either?
To me, this is the crux of the issue. Arguing that the US is a better business environment so you should only invest here is essentially an argument against efficient markets and presumes the rest of investors worldwide don't fully realize this and doesn't price it in. Thus from an academic perspective to me the argument doesn't hold water.

But currency risk is an added risk, for which there is no implicit return. So it can be argued that excessive exposure to non home currency increases your risk with no return. On the flip side I think there is some evidence that a modest allocation of international does decrease your risk in spite of currency risks.

To me, your last point is the real variable. We tend to define risk as we have historically experienced it. But there is a risk out there that we haven't experienced, a large devaluation of the dollar and/or Japan style crash limited to the US. That just doesn't seem likely, but it is a greater than zero possibility and would be catastrophic for US only investors. But how do you quantify the value of this potential benefit of a low probability catastrophic scenario? It is impossible to do. The result is some choose to dismiss it as the zombie apocalypse and it if happens we will be eating MREs anyway so why worry about. I don't hold that view. The result is I'm somewhere between 35-40% international.

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Re: Justifying Non World Market Cap

Post by bgf » Sat Nov 02, 2019 6:30 am

305pelusa wrote:
Fri Nov 01, 2019 9:35 pm
era00100 wrote:
Fri Nov 01, 2019 7:43 pm

Another argument that you didn't mention (at least not explicitly) is the home bias, which most investors face, even if they live in Germany, or Peru... For U.S. investors, the vast majority of them will need to spend from their portfolios in U.S. dollars, not euros or yen or any other currency. So, to me it makes sense to lean toward U.S. investments, either bonds or stocks. For what it's worth, I'm between 20 and 25% in International stocks and bonds.

Regards,
The currency argument does make the most sense. But wouldn’t the international stock prices change if the value of their currency changes? Also, maybe it could be a good idea to diversify across currencies, as the dollar isn’t necessarily safe either?
The currency argument actually makes no sense. It's one of those things that sound correct ("if you spend in dollars then your investments should be in dollars") but there's no actual logic behind it.

Here's two "arguments" I've heard:
1) If there's US inflation, then your US equities, a claim on a real asset, will go up too. This is true over long terms. It's also true of international equities where, thanks to the more favorable exchange rate in the presence of US inflation, would be, if anything, better here.
2) Currencies don't have real returns so don't take on foreign currency risk. Foreign currency risk being that a country will suffer high inflation, its currency will depreciate, and your holdings in that currency will be worth less. I guess these people believe there's no domestic currency risk then and that the dollar is forever stable. Although you already realize this is wrong; you astutely notice that there's no real return on holding dollars either, so might as well diversify across other currencies. That way the only inflation that could really affect your retirement would be a global inflation (much less likely that any one country!).
i think if you are matching known liabilities, it is a prudent thing to do, which is why companies go long other currencies or engage in hedging for international operations. im certainly no expert on the subject however. as with my investing, i rely on and trust others to make those decisions for me.
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retired@50
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Re: Justifying Non World Market Cap

Post by retired@50 » Sat Nov 02, 2019 9:11 am

bgf wrote:
Sat Nov 02, 2019 6:30 am
305pelusa wrote:
Fri Nov 01, 2019 9:35 pm
era00100 wrote:
Fri Nov 01, 2019 7:43 pm

Another argument that you didn't mention (at least not explicitly) is the home bias, which most investors face, even if they live in Germany, or Peru... For U.S. investors, the vast majority of them will need to spend from their portfolios in U.S. dollars, not euros or yen or any other currency. So, to me it makes sense to lean toward U.S. investments, either bonds or stocks. For what it's worth, I'm between 20 and 25% in International stocks and bonds.

Regards,
The currency argument does make the most sense. But wouldn’t the international stock prices change if the value of their currency changes? Also, maybe it could be a good idea to diversify across currencies, as the dollar isn’t necessarily safe either?
The currency argument actually makes no sense. It's one of those things that sound correct ("if you spend in dollars then your investments should be in dollars") but there's no actual logic behind it.

Here's two "arguments" I've heard:
1) If there's US inflation, then your US equities, a claim on a real asset, will go up too. This is true over long terms. It's also true of international equities where, thanks to the more favorable exchange rate in the presence of US inflation, would be, if anything, better here.
2) Currencies don't have real returns so don't take on foreign currency risk. Foreign currency risk being that a country will suffer high inflation, its currency will depreciate, and your holdings in that currency will be worth less. I guess these people believe there's no domestic currency risk then and that the dollar is forever stable. Although you already realize this is wrong; you astutely notice that there's no real return on holding dollars either, so might as well diversify across other currencies. That way the only inflation that could really affect your retirement would be a global inflation (much less likely that any one country!).
i think if you are matching known liabilities, it is a prudent thing to do, which is why companies go long other currencies or engage in hedging for international operations. im certainly no expert on the subject however. as with my investing, i rely on and trust others to make those decisions for me.
Since it was my quoted passage that seemed to get this whole thing started, I thought I'd clarify what I meant.
When I said
"For U.S. investors, the vast majority of them will need to spend from their portfolios in U.S. dollars, not euros or yen or any other currency. So, to me it makes sense to lean toward U.S. investments, either bonds or stocks."

I was referring to the following passage from the Vanguard website for the VTIAX fund.
Currency risk: The chance that the value of a foreign investment, measured in U.S. dollars, will decrease because of unfavorable changes in currency exchange rates.

Regards,

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Re: Justifying Non World Market Cap

Post by Forester » Sat Nov 02, 2019 9:44 am

One issue for American investors, is diversifying into international stocks undiversifies them in regard to industry concentration, for example Emerging Markets Value, touted as the sub-class with the highest forward returns, is 57.37% financials-energy-materials. EM Value may or may not do well in the next decade but this is something to bear in mind.

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Re: Justifying Non World Market Cap

Post by JoMoney » Sat Nov 02, 2019 11:51 am

It makes sense for reasons beyond just the "familiarity" bias that people have with business in their home country (and I've never seen a persuasive argument for why one should invest more in things they have relatively lower quality information on). Different individuals in different locations have different legal recourse, have different tax considerations, have liabilities in different currencies, and have different expenses when it comes to buying foreign relative to domestic. Different markets also have different risk profiles, and people don't have the same risk preferences.
Despite the economic-liberal dream model of a universal open market with no regulation and unlimited liquidity, the real world doesn't operate that way, and never will (liberal paradox), - there is no globally "efficient" market that's "efficient" for all individuals everywhere.
I don't have the links to the latest data handy, but in the past Federal Reserve balance of U.S. accounts data has shown that the broad average for the U.S. is holding about 20% of foreign equity... and that's a higher amount than what foreign holders have in U.S. equity... so to the extent that "home bias" exists relative to global market-cap, it's higher outside the U.S. then in it (and I'm not arguing that's good or bad).
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: Justifying Non World Market Cap

Post by Ocean77 » Sat Nov 02, 2019 12:03 pm

Forester wrote:
Sat Nov 02, 2019 9:44 am
One issue for American investors, is diversifying into international stocks undiversifies them in regard to industry concentration, for example Emerging Markets Value, touted as the sub-class with the highest forward returns, is 57.37% financials-energy-materials. EM Value may or may not do well in the next decade but this is something to bear in mind.
If one adds this EM Value to a US stock portfolio, it looks like the energy and materials sectors would rather be a nice counter-weight / diversification for the usually tech heavy American indexes. Especially if it's added in moderation, like 5 or 10%.

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Re: Justifying Non World Market Cap

Post by stan1 » Sat Nov 02, 2019 12:09 pm

rascott wrote:
Fri Nov 01, 2019 10:04 pm
Seeing the currency issue aside..... if one plans to live in the US for the rest of their life, like most will..... and say the US economy outperforms going forward over the next 30 years..... doesn't a global investor risk "falling behind" most of the rest of the country that is heavily home biased towards US markets?
By all means if you believe the US economy will outperform significantly for the next 30 years you should only invest in US equities. That's back to my point of logic, faulty logic, and emotion. Do what you want. It's your money. Just be honest with yourself. Use logic or just admit you are making an emotional decision. Emotional decisions are better than flawed logic and rationalizations. "I'm an American and I want to invest in America" is a much better answer than "US companies are multi-national so no need to invest outside the US".

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Re: Justifying Non World Market Cap

Post by longinvest » Sat Nov 02, 2019 12:27 pm

It doesn't have to be all or nothing (e.g. 100% world capitalization weighting or 100% US).

It's actually quite reasonable for investors, worldwide, to keep some home bias in a globally-diversified portfolio for various reasons (see the Vanguard paper I linked to, earlier in this thread). A very good example of a reasonable allocation, for a US investor, is found in the all-in-one Vanguard LifeStrategy Moderate Growth Fund (VSMGX), a globally-diversified balanced index fund with a moderate amount of home bias. It's a portfolio that diversifies across stocks and bonds, as well as across US and international for both assets.

Many investors would benefit from investing into such a well-constructed and automatically rebalanced all-in-one fund. It would allow them to stop worrying about minute portfolio details. I'm in favor of the use of such a well-diversified One-Fund Portfolio all lifelong.
Bogleheads investment philosophy | single-ETF balanced portfolio (VBAL) | VPW accumulation

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Re: Justifying Non World Market Cap

Post by nisiprius » Sat Nov 02, 2019 1:24 pm

We don't have to "justify" it in the sense of needing to prove that what we are doing is an optimum.

John C. Bogle has written "Successful investing involves doing just a few things right and avoiding serious mistakes." Even if it is a mistake, departing from world market cap is not a serious mistake. Or, the other way around, if investing outside the US is a mistake, it is not a serious mistake.

The theoretical argument for cap-weighting is that in a single market with rational actors trading frictionlessly, and other assumptions that are not perfectly true nor wildly insane, cap-weighting--matching the market portfolio--gives you the highest Sharpe ratio (risk-adjusted reward).

First, maybe the US stock market roughly resembles a single market with frictionless trading. But there is no such thing as "the global stock market," there are a couple of dozen individual national markets. And they are not frictionless, because money can't equilibrate between them without going through currency conversions. So the basis for saying the market portfolio is an optimum is shakier than it is for investing within the US market.

Second, theoretical claims that something is optimum need to be tempered with some discussion of how much difference it makes if you are somewhat off the optimum.

For example, this is from a presentation by Vanguard supporting global market-capitalization weight: Global equity investing: The benefits of diversification and sizing your allocation One of their arguments is that it reduces volatility through diversification, and they illustrate this point with this chart:

Image

Let's take this completely at face value. Let's say I'm on the green line. The optimum appears to be at about 40% non-U.S. (which, interestingly, is below cap weight). But I, personally, am at 20%. So instead of getting about 4.3% less volatility, I am getting 3.2% less, or to put it another way, I'm getting 75% of the benefit I'd be getting at full global cap weight.

Now we're already close to the angels-dancing-on-the-head-of-a-pin here--Vanguard is showing simulations, not real data, for example. But if you say "Hey, you're way off the optimum, how do you 'justify' that," my answer is "I don't need to justify it. I don't need to be on the optimum. And I don't believe any of this stuff is very predictive going forward, anyway. But whatever I'm supposed to be getting out of it, according to Vanguard I'm getting 3/4 of it anyway, and that's good enough for me."

And if someone says "why settle for suboptimal when you can get optimal" my answer is, a, because it doesn't matter to me, and b, because you don't know what is optimal and neither do I. Maybe my portfolio is suboptimal, but maybe it isn't. What I believe is if it is suboptimal, it's not by an amount that's big enough to count as a "serious mistake."
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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305pelusa
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Re: Justifying Non World Market Cap

Post by 305pelusa » Sat Nov 02, 2019 2:11 pm

nisiprius wrote:
Sat Nov 02, 2019 1:24 pm
We don't have to "justify" it in the sense of needing to prove that what we are doing is an optimum.

John C. Bogle has written "Successful investing involves doing just a few things right and avoiding serious mistakes." Even if it is a mistake, departing from world market cap is not a serious mistake. Or, the other way around, if investing outside the US is a mistake, it is not a serious mistake.

The theoretical argument for cap-weighting is that in a single market with rational actors trading frictionlessly, and other assumptions that are not perfectly true nor wildly insane, cap-weighting--matching the market portfolio--gives you the highest Sharpe ratio (risk-adjusted reward).

First, maybe the US stock market roughly resembles a single market with frictionless trading. But there is no such thing as "the global stock market," there are a couple of dozen individual national markets. And they are not frictionless, because money can't equilibrate between them without going through currency conversions. So the basis for saying the market portfolio is an optimum is shakier than it is for investing within the US market.

Second, theoretical claims that something is optimum need to be tempered with some discussion of how much difference it makes if you are somewhat off the optimum.

For example, this is from a presentation by Vanguard supporting global market-capitalization weight: Global equity investing: The benefits of diversification and sizing your allocation One of their arguments is that it reduces volatility through diversification, and they illustrate this point with this chart:

Image

Let's take this completely at face value. Let's say I'm on the green line. The optimum appears to be at about 40% non-U.S. (which, interestingly, is below cap weight). But I, personally, am at 20%. So instead of getting about 4.3% less volatility, I am getting 3.2% less, or to put it another way, I'm getting 75% of the benefit I'd be getting at full global cap weight.

Now we're already close to the angels-dancing-on-the-head-of-a-pin here--Vanguard is showing simulations, not real data, for example. But if you say "Hey, you're way off the optimum, how do you 'justify' that," my answer is "I don't need to justify it. I don't need to be on the optimum. And I don't believe any of this stuff is very predictive going forward, anyway. But whatever I'm supposed to be getting out of it, according to Vanguard I'm getting 3/4 of it anyway, and that's good enough for me."

And if someone says "why settle for suboptimal when you can get optimal" my answer is, a, because it doesn't matter to me, and b, because you don't know what is optimal and neither do I. Maybe my portfolio is suboptimal, but maybe it isn't. What I believe is if it is suboptimal, it's not by an amount that's big enough to count as a "serious mistake."
If the risk of stocks and investing could truly be summarized by St Dev and Vanguard's models, I would agree that being close to the optimal historical 40% is good enough.

I don't think that though. I'm thinking of far more serious risks, like heavy dollar inflation, potential internal conflict (a civil war) and other forms of what Bernstein calls Deep Risk.

Diversification isn't just some mathematical tool to optimize. It fundamentally also is "don't keep your eggs in one basket". IMO, investing only domestically (or 80%+ on it) opens the potential for a truly "serious mistake" as Bogle says. We just don't notice it (and St Dec doesn't capture it) due to the problem of induction. I don't buy the argument that if something terrible occurs in the US, it will occur everywhere else. Even if that's true, why risk it? No one is compensating me for a country bias, whether I live there or not.

Just some thoughts

lostdog
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Re: Justifying Non World Market Cap

Post by lostdog » Sat Nov 02, 2019 2:13 pm

Vanguard will go from 40% international to world market cap when the older generation moves on. There is still quite a bit of the old ideology. You see it on this board in the international debate threads. Vanguard knows this.

There is a lot of money still around within the older crowd so Vanguard doesn't want to push it too much.
VTWAX and chill.

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hisdudeness
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Re: Justifying Non World Market Cap

Post by hisdudeness » Sat Nov 02, 2019 5:10 pm

nisiprius wrote:
Sat Nov 02, 2019 1:24 pm
We don't have to "justify" it in the sense of needing to prove that what we are doing is an optimum.

John C. Bogle has written "Successful investing involves doing just a few things right and avoiding serious mistakes." Even if it is a mistake, departing from world market cap is not a serious mistake. Or, the other way around, if investing outside the US is a mistake, it is not a serious mistake.

The theoretical argument for cap-weighting is that in a single market with rational actors trading frictionlessly, and other assumptions that are not perfectly true nor wildly insane, cap-weighting--matching the market portfolio--gives you the highest Sharpe ratio (risk-adjusted reward).

First, maybe the US stock market roughly resembles a single market with frictionless trading. But there is no such thing as "the global stock market," there are a couple of dozen individual national markets. And they are not frictionless, because money can't equilibrate between them without going through currency conversions. So the basis for saying the market portfolio is an optimum is shakier than it is for investing within the US market.

Second, theoretical claims that something is optimum need to be tempered with some discussion of how much difference it makes if you are somewhat off the optimum.

For example, this is from a presentation by Vanguard supporting global market-capitalization weight: Global equity investing: The benefits of diversification and sizing your allocation One of their arguments is that it reduces volatility through diversification, and they illustrate this point with this chart:

Image

Let's take this completely at face value. Let's say I'm on the green line. The optimum appears to be at about 40% non-U.S. (which, interestingly, is below cap weight). But I, personally, am at 20%. So instead of getting about 4.3% less volatility, I am getting 3.2% less, or to put it another way, I'm getting 75% of the benefit I'd be getting at full global cap weight.

Now we're already close to the angels-dancing-on-the-head-of-a-pin here--Vanguard is showing simulations, not real data, for example. But if you say "Hey, you're way off the optimum, how do you 'justify' that," my answer is "I don't need to justify it. I don't need to be on the optimum. And I don't believe any of this stuff is very predictive going forward, anyway. But whatever I'm supposed to be getting out of it, according to Vanguard I'm getting 3/4 of it anyway, and that's good enough for me."

And if someone says "why settle for suboptimal when you can get optimal" my answer is, a, because it doesn't matter to me, and b, because you don't know what is optimal and neither do I. Maybe my portfolio is suboptimal, but maybe it isn't. What I believe is if it is suboptimal, it's not by an amount that's big enough to count as a "serious mistake."
Nisiprius, you have a heckuva knack for making complex things understandable, and I appreciate your posts.

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hisdudeness
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Re: Justifying Non World Market Cap

Post by hisdudeness » Sat Nov 02, 2019 5:35 pm

lostdog wrote:
Sat Nov 02, 2019 2:13 pm
Vanguard will go from 40% international to world market cap when the older generation moves on. There is still quite a bit of the old ideology. You see it on this board in the international debate threads. Vanguard knows this.

There is a lot of money still around within the older crowd so Vanguard doesn't want to push it too much.
I use Vanguard, and have no complaints. But I think you are putting way too much faith in what they think. and in what you think they think.
But maybe I'm just senile and need a nap...
Last edited by hisdudeness on Sat Nov 02, 2019 8:28 pm, edited 1 time in total.

Northern Flicker
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Re: Justifying Non World Market Cap

Post by Northern Flicker » Sat Nov 02, 2019 5:42 pm

lostdog wrote:
Sat Nov 02, 2019 2:13 pm
Vanguard will go from 40% international to world market cap when the older generation moves on. There is still quite a bit of the old ideology. You see it on this board in the international debate threads. Vanguard knows this.

There is a lot of money still around within the older crowd so Vanguard doesn't want to push it too much.
Affected funds would be Target Retirement and LifeStrategy products.

What percentage of Vanguard assets are in these funds?

What percentage of assets of older investors are in these funds?

Why would Vanguard choose an allocation that their own research considers to be sub-optimal?
Index fund investor since 1987.

Trader Joe
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Re: Justifying Non World Market Cap

Post by Trader Joe » Sat Nov 02, 2019 5:46 pm

era00100 wrote:
Fri Nov 01, 2019 7:11 pm
Most Bogleheads (generally) use a find like VTSAX for the US market, which follows market cap. Market cap is seen as a great passive way to select a portfolio of US stocks.

However, it seems like there is less consistency with Bogleheads when it comes to the world market cap.

The current Vanguard world fund has 55% US, and 45% ex-US. Most Bogleheads it seems use more than 55% US cap. The arguments Iv seen (which I do not doubt) are things like the US is the best environment for investing and business building, better regulations, and other similar arguments.

While these could be true, in theory, couldn’t the market (i.e. market cap) decide these weights and ultimately the weights from a fund like the Vanguard World Fund would be appropriate?

I’m curious about arguments for side stepping market cap weighting when it comes to US vs International stocks.

Eric
As an American living in the United States, I am 100% invested in VFIAX (Vanguard 500 Index Fund Admiral Shares). I am very happy with my investment results. No need to justify anything.

bgf
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Re: Justifying Non World Market Cap

Post by bgf » Sat Nov 02, 2019 5:56 pm

should i invest in international companies?
yes, i think id like to do that. there are a lot of great companies worldwide, and id love to be a part owner of them. i can do so easily and cheaply. yay!

ugh, so how much should i invest then? 10%? 20%? 40%? 60%? ugh, i just dont know! how am i to choose? should it change over time???
well, i invest in US based on market cap, i guess i'll do the same for international. it'll change all the time, but I'll never have to make another decision about it. yay!

well, thats settled.

should i own bonds? .....

...
“TE OCCIDERE POSSUNT SED TE EDERE NON POSSUNT NEFAS EST"

longinvest
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Re: Justifying Non World Market Cap

Post by longinvest » Sat Nov 02, 2019 6:53 pm

bgf wrote:
Sat Nov 02, 2019 5:56 pm
should i invest in international companies?
yes, i think id like to do that. there are a lot of great companies worldwide, and id love to be a part owner of them. i can do so easily and cheaply. yay!

ugh, so how much should i invest then? 10%? 20%? 40%? 60%? ugh, i just dont know! how am i to choose? should it change over time???
well, i invest in US based on market cap, i guess i'll do the same for international. it'll change all the time, but I'll never have to make another decision about it. yay!

well, thats settled.

should i own bonds? .....

...
How about putting it all into the good enough LifeStrategy Moderate Growth Fund (VSMGX) and calling it a day? See this thread for details. :wink:
Bogleheads investment philosophy | single-ETF balanced portfolio (VBAL) | VPW accumulation

columbia
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Re: Justifying Non World Market Cap

Post by columbia » Sat Nov 02, 2019 6:58 pm

lostdog wrote:
Sat Nov 02, 2019 2:13 pm
Vanguard will go from 40% international to world market cap when the older generation moves on. There is still quite a bit of the old ideology. You see it on this board in the international debate threads. Vanguard knows this.

There is a lot of money still around within the older crowd so Vanguard doesn't want to push it too much.
This is some pretty overt ageism.

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JoMoney
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Re: Justifying Non World Market Cap

Post by JoMoney » Sat Nov 02, 2019 7:15 pm

columbia wrote:
Sat Nov 02, 2019 6:58 pm
lostdog wrote:
Sat Nov 02, 2019 2:13 pm
Vanguard will go from 40% international to world market cap when the older generation moves on. There is still quite a bit of the old ideology. You see it on this board in the international debate threads. Vanguard knows this.

There is a lot of money still around within the older crowd so Vanguard doesn't want to push it too much.
This is some pretty overt ageism.
The assumption of what peoples age groups are is a bit presumptuous, as is the predictions of what "vanguard will do" in the future, and the rationale for doing so.
Some might find an "old ideology" that works for them preferable to one that doesn't.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

snailderby
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Re: Justifying Non World Market Cap

Post by snailderby » Sat Nov 02, 2019 7:42 pm

JoMoney wrote:
Sat Nov 02, 2019 7:15 pm
columbia wrote:
Sat Nov 02, 2019 6:58 pm
lostdog wrote:
Sat Nov 02, 2019 2:13 pm
Vanguard will go from 40% international to world market cap when the older generation moves on. There is still quite a bit of the old ideology. You see it on this board in the international debate threads. Vanguard knows this.

There is a lot of money still around within the older crowd so Vanguard doesn't want to push it too much.
This is some pretty overt ageism.
The assumption of what peoples age groups are is a bit presumptuous, as is the predictions of what "vanguard will do" in the future, and the rationale for doing so.
Some might find an "old ideology" that works for them preferable to one that doesn't.
For what it's worth, as a younger investor, I think there are good reasons to hold less than market cap in international stocks. Siamond's Investing in the World series was very helpful for me. See viewtopic.php?t=270186 and https://finpage.blog/2017/03/18/investi ... ld-part-1/.

I want to hold some international stocks in case the U.S. becomes the next Japan. But I don't want to take on more currency risk or extra volatility than I have to. If U.S. stocks tank for the next two decades, I may regret not holding more international stocks...or vice versa. But that's a balance that every investor will have to strike.
Last edited by snailderby on Sat Nov 02, 2019 7:51 pm, edited 3 times in total.

columbia
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Re: Justifying Non World Market Cap

Post by columbia » Sat Nov 02, 2019 7:48 pm

JoMoney wrote:
Sat Nov 02, 2019 7:15 pm
columbia wrote:
Sat Nov 02, 2019 6:58 pm
lostdog wrote:
Sat Nov 02, 2019 2:13 pm
Vanguard will go from 40% international to world market cap when the older generation moves on. There is still quite a bit of the old ideology. You see it on this board in the international debate threads. Vanguard knows this.

There is a lot of money still around within the older crowd so Vanguard doesn't want to push it too much.
This is some pretty overt ageism.
The assumption of what peoples age groups are is a bit presumptuous, as is the predictions of what "vanguard will do" in the future, and the rationale for doing so.
Some might find an "old ideology" that works for them preferable to one that doesn't.
I guess we’ll have truly efficient global markets once every person over __ drops dead.

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unclescrooge
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Re: Justifying Non World Market Cap

Post by unclescrooge » Fri Nov 08, 2019 2:38 pm

Forester wrote:
Sat Nov 02, 2019 9:44 am
One issue for American investors, is diversifying into international stocks undiversifies them in regard to industry concentration, for example Emerging Markets Value, touted as the sub-class with the highest forward returns, is 57.37% financials-energy-materials. EM Value may or may not do well in the next decade but this is something to bear in mind.
You can exclude state owned enterprises and thus tilt away from this overweight quite easily.

Alchemist
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Re: Justifying Non World Market Cap

Post by Alchemist » Fri Nov 08, 2019 6:05 pm

lostdog wrote:
Sat Nov 02, 2019 2:13 pm
Vanguard will go from 40% international to world market cap when the older generation moves on. There is still quite a bit of the old ideology. You see it on this board in the international debate threads. Vanguard knows this.

There is a lot of money still around within the older crowd so Vanguard doesn't want to push it too much.
I am a millennial and am 100% U.S. on my stock investments. Most the people arguing in favor of international investing seem to be a bit older, not younger, than me.

Though I do believe Vanguard's goal is to move to full market cap weight, but this has nothing to do with the age of its customers and everything to do a cultural shift that favors the strong version of the EMH within Vanguard's leadership.

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Phineas J. Whoopee
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Re: Justifying Non World Market Cap

Post by Phineas J. Whoopee » Fri Nov 08, 2019 7:57 pm

I've posted this information before so it isn't a new revelation, but it was quite a while ago.

In equities I'm 60% US and 40% international, total stock index funds in each case. I mix my own portfolio, without relying on some company to do it for me. Eventually that may stop being practical, but it's likely to be a lot of years from now.

I began with world market cap, which is not constant, then tilted slightly toward the US because, as others wrote upthread, I expect to retire and need to spend money inside the US. It's only a mild tilt.

Now that they're readily available in low-cost funds I carefully considered adding US Dollar denominated or currency hedged international fixed income. My analysis showed that in my own case it would make little difference, so I didn't choose it.

With respect to my portfolio and life I view my role as that of a risk manager, not a return maximizer.

I wish we would stop calling each other names, based on ages or anything else.

PJW

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