All over financial news and blogs, you would’ve seen many preaching the benefits of dollar cost averaging into a low cost index fund. The S&P 500 is commonly being used as the proxy.
While this is generally sound advice, there is just one problem.
It is primarily focused on the U.S. This introduces an element of country/ geographical risk.
While the U.S stock market has outperformed international stocks in recent decades, the tide could turn in the blink of an eye.
The U.S stock market makes up about 50% of the global market. U.S investors allocate 80% of their portfolio to U.S companies on average.
Most of the companies in the S&P 500 companies are well-established with lots of media coverage.
With the level of investments flowing into these index funds, the level of returns we’re getting (while decent), isn’t great.
So we might not end up getting the actual growth that the emerging economies are going through just by investing in these large multi-national companies.
Focusing solely on the S&P 500 companies means we’re not gaining exposure to market leaders outside the U.S.
It also means that we may have to put up with decades of underperformance in the future.
If the Japanese stock market can go nowhere for a good 3 decades, who’s to say the same won’t happen with the U.S stock market?
U.S vs International
Based on the chart above, there are a good few periods of underperformance in the U.S stock markets.
Stock markets around the world move in cycles. They take turns to have their day in the sun.
Remember how the tech sector was the stock market darling in 2021, pushing many tech stocks to the moon.
But many of them ended up selling following year in 2022.
A handful of quality tech companies recovered and made new all time highs. The others, however, never recovered after the crash.
Stock price doesn’t lie.
How to invest outside the U.S
A good way to diversify away geographical risk is to use an ETF that gives us exposure to equity markets outside of the U.S.
Here are 2 ETFs to consider.
Vanguard Total International Stock ETF (VXUS) - This ETF gives us broad exposure across developed and emerging non-U.S. equity markets.
iShares Core MSCI Total International Stock ETF (IXUS) - This ETF tracks the MSCI ACWI ex USA IMI Index, an index of international developed and emerging market companies across the market capitalisation spectrum.
These ETFs are to be used in combination with, not as a replacement for the S&P500.
Conclusion
It’s not easy diversifying your portfolio outside of the U.S.
If you do, there are sure to be periods of underperformance, which will make you doubt if you’re making the right decision.
But over the long run, having a well diversified international portfolio reduces volatility, while giving us exposure to markets we otherwise might not have.
When the dry spell for the S&P500 arrives (which it inevitably will), at least we know we’re prepared.
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