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The Case for Owning International Stocks

Should you go global with your investment portfolio?

hands holding international flags - investing international

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Is owning international stocks a smart way to diversify your investment portfolio?

Vanguard founder John C. Bogle has long argued against the need for stocks to go global. Though I rarely disagree with Bogle, I do in this case. I'll present his argument, tell you why I disagree, then close with my take on an even more important decision.

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Bogle's case

In an interview with Bloomberg View's Barry Ritholtz, Bogle summarized his views. First, he argues that, by owning the S&P 500 stock index (through an index fund), you already own international stocks. "U.S. companies get half of their revenues ... and half of their earnings from outside the U.S.," Bogle said on Ritholtz's "Masters in Business" podcast. Next, he points out that an international index fund has 45 percent of its holdings in the U.K., France and Japan. Those are countries with serious problems, Bogle says.

So Bogle concludes that owning a broad U.S. stock index fund, such as the Vanguard 500 Index Fund (VFINX) or Vanguard Total Stock Market Index Fund (VTSMX), is a better way to get international exposure.

Why I disagree

I don't dispute Bogle's facts, just his conclusion. If one had enough international exposure by owning U.S. stocks, there wouldn't be such significant differences between U.S. and international stock performance. For example, from 2003 to 2007, the U.S. total stock index fund gained 85 percent, while the Vanguard Total International Stock Index Fund (VGTSX) gained 186 percent. U.S. stocks then performed much better after that period. The large performance differences between U.S. and international stocks is strong evidence that international companies have a much greater percentage of their business outside the U.S. than U.S. companies. Thus, owning international stocks helps diversify.

Why then would anyone want to invest in countries with slower-growing economies and lots of problems? It may sound intuitive that faster-growing economies make better investments, but there is no link between GDP growth and stock performance. A recent example is that emerging market stock performance has badly lagged behind that of developed countries over the past five years, yet their economies grow at a faster rate.

An analogy can be made with U.S. companies. Fast-growing companies are known as growth companies, while slow-growing companies are labeled value. There is significant evidence that value investing has outperformed growth investing in the long run. Thus, the slower-growing U.K., France and Japan may be value countries. I asked Bogle about that, and he responded: "I'm not sure describing them as 'value' countries is valid. After all, price-to-earnings (P/E) ratios may be low because risk is high."

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Bogle concluded an email to me by saying, "Allan, I've always reminded anyone who listens that my global view may be wrong. But even if it is, I'm betting that the long-term differences in returns on U.S. vs. foreign stocks will not be large enough to matter."

My take

To put it simply, I wouldn't buy stocks only in my home state (Colorado) and neither should you. So I expand that argument to our home country as well. In fact, I'd invest in an interstellar index fund if one existed and had low enough costs.

Last year, Vanguard increased its allocation of the stock portion in target date retirement funds from 30 percent international to 40 percent. Many experts believe that international stock valuations have become more attractive.

No one knows whether U.S. stocks will perform better than international stocks over the next decade. I've long advised that the stock portion of a portfolio should be two-thirds U.S. and one-third international. In 2007, the typical response was something like, "Why only a third, since international will outperform?" Now that international stocks have lagged, I hear things like, "Why so much in international stocks when there are so many problems overseas?" This is known as performance chasing, and it doesn't work.

But whether you agree with me or with Bogle, the most important question you should ask yourself is not "Should I own international stocks?" Rather, it's "Am I willing to commit to a position and stay the course?" Moving in and out (aka trying to time the market) is hazardous to your wealth.

Allan Roth is the founder of Wealth Logic, an hourly based financial planning firm in Colorado Springs, Colo. He has taught investing and finance at universities and written for Money magazine, the Wall Street Journal and others. His contributions aren't meant to convey specific investment advice.

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