Don’t Forget International Stocks

I received a question from a long-time reader, noting the multi-year underperformance of non-US stocks relative to US stocks. 

Over a 10-year interval, he noted, international stocks very rarely outperformed US stocks, and concluded that it “makes me wonder why any asset manager would invest more than a token amount in international stocks, funds, or ETFs.”

I wildly disagree with his conclusion, but it is a great question. What exactly is the point of investing in international stocks, especially those that just seem to do worse than US stocks over a decade?

To begin, can we nerd-out for a moment on portfolio theory? We start with the first principle that we choose assets because they offer a return. But unfortunately, they also carry some risk.

Patriotism is not a good portfolio reason to own only American

As a second principle, we also assume that we want to maximize returns, while minimizing risk. More returns = good. More risk = bad. 

Portfolio theory says that you can accomplish the goal – more returns and lower risk – by owning more than one investment.

If you have two (or more) investments (or mutual funds, in our analysis) that are not perfectly correlated, then portfolio theory says that you improve your combination of risk and return – as a combination, as a portfolio – when you combine these two (or more) assets.

The key ingredient to this recipe working is non-correlation between the investments. In non-technical terms, when one asset zigs, the other one zags. Underperformance during some period of time with one asset will be offset and blended with outperformance of the other asset.

When you combine a US-based mutual fund with an international-based mutual fund, portfolio theory does not promise you better returns. Instead, it promises that the combination will, over time, get you closer to the maximum return on your portfolio for a given level of blended portfolio risk. 

To be sure, the highest returns possible often come from concentrated, undiversified, investments. However, those returns may come at a cost of higher risk than may be prudent. 

The theoretical language we use (I mean, financial theorists use) is approaching the “efficient frontier” of risk and return, through diversification.

The clearest explanations I’ve ever read of this comes from a 2013 book by Lars Kroijer, Investing Demystified: How To Invest Without Speculation and Sleepless Nights, which carefully threads the needle between plain language and an academic financial nerd festival. Which is to say, I recommend it.

Kroijer offers strong advice that directly addresses my reader’s question about whether to bother with both international and domestic funds. His advice, which I endorse, is that there is no rational reason to have more US stock exposure than the proportion of global stocks that are based in the US. Which, if you’re curious, is about 37 percent right now. I’ve never met an American stock investor who had such a low percentage of stock investments in their portfolio. But I present it as an anchoring idea, in order to be challenging. In my stock mutual fund portfolio, I’m at 60 percent US, 40 percent international. Which, again, I’ll guess is still more international than most.

A historical note. Japanese investors experienced approximately zero price appreciation if they bought only the Nikkei 225 Index 30 years ago, versus a roughly ten-fold appreciation in prices of the US-based S&P 500 Index. Including dividends, the 30-year return on the Nikkei versus the S&P 500 is roughly 50 percent versus 1800 percent, respectively. I’m not adjusting for inflation here.

For Japanese investors, owning only the main stock index of their own country would be a very expensive choice, over this 30 year long run. The point is not that Japanese stocks are bad and US stocks are good. The point is that owning only investment assets from your own country can be an extremely poor decision. Which you only learn in retrospect.

Nikkei 225
Nikkei 225 Index price ended 30 years roughly flat, from 1990 to 2020

People who grow up in countries outside the US and who have an appreciable net worth rarely make this same choice. They hedge their risks by owning non-domestic assets, stocks, real estate and currencies. Wealthy Mexican nationals who lived through the 1982 banking crisis or the 1994 currency crisis wouldn’t dream of owning only Mexican assets denominated in Mexican pesos. Wealthy Brits who lived through the pound devaluation in 1992 feel the same way. Or wealthy Russians during the 1998 devaluation. Same with anyone who grew up anywhere in Latin America at any time in the last one hundred years. You get the idea.

Lots of easy caveats and corrections may be applied to this theory of international diversification I’ve presented. One, for example, is that many US multinational companies provide exposure to developed and emerging market economies, so that a US-based portfolio still has quite a bit of global exposure embedded in it. Ok, sure, I partly agree.

Another argument is that a strong tradition of rule of law and regulatory protection makes US-investing inherently superior to non-US investing, for now and for the foreseeable future. I don’t disagree with the initial observation, but I would argue that prices, market capitalization, and future returns will efficiently reflect those institutional differences, over time. Including, especially, in the future.

At the risk of being accused of unpatriotic thoughts, I would also argue that US exceptionalism was real in the past, may still mean something in the present, but isn’t something I would permanently bank on for the future. A main point of portfolio theory investing is that we don’t know what will happen in the future. We can’t control the future, but we can manage our risk and return – as close to the efficient frontier as possible – through diversification.

Another key caveat is that international stocks have become more correlated with US stocks over the past few decades, so we achieve less non-correlation in recent years than we would want from non-US investing. That’s not a reason to not diversify, but rather, a reason to stay vigilant about correlations.

If you broaden your risk examination beyond the stocks you own to think about other financial risks – risks of real estate you own, risks to your income, and risks to your currency exposure, you might realize that many of your eggs are kept in the same US, dollar-denominated basket. Your risks actually stack on top of one another in a correlated way. For portfolio theory to give you the best returns at a given risk, you want to seek out less correlated, or non-correlated, risks.

So, in sum, even if your international stocks have underperformed your US stocks, it doesn’t mean you should give up international exposure in your portfolio. 

To restate, for emphasis: The majority of US investors are woefully underinvested in non-US assets. We are exposed to our own country’s risk to a degree people from other countries – from hard-won experience – would never, ever, dream of being.

A version of this post ran in the San Antonio Express-News

Please see related posts:

Book Review: Investing Demystified by Lars Kroijer

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Interview: Author Lars Kroijer (Part I) – on Global Diversification


In the first section of this interview with author Lars Kroijer we talk about his idea, from the book Investing Demystified, that we should all seek portfolio exposure to the broadest segment of global equities – essentially all 95 stock markets in the world.  In the second part of this interview we talk about the opposite – namely the dangers of concentrating all of your investment portfolio within, say, your home country.


Michael:          I’m talking to Lars Kroijer, [/Kroy’-er/] the author of Investing Demystified which I’ve reviewed on the Bankers Anonymous site. First things first, I read your book and I agree with a ton of it, the theory. And then I thought about my own portfolio, and I thought I’m two-thirds the way towards what you’re saying. By that I mean I invest in index-only Russell 2000 index funds. Talking about my retirement portfolio. I halfway embraced what I think is – in shorthand – an efficient market hypothesis. But I’m not entirely there, so tell me about why I’m doing it wrong.

Lars:                It’s an interesting place to start because you are doing it less wrong than most people in the world would be. You being an American investing in a very broad US index, you are already invested in a very large portion of the world-equity portfolio. What I would normally tell people is you need to invest cheaply and extremely broadly in equity indices for your equity exposure.

Now what does that mean? That means all equities traded in the world.  I think there are 95 public equity markets in the world today, and you should be invested in all those in proportion to their values. You’re only invested in one, the US one, but that’s the biggest one by a very large margin. So failing to invest abroad is less of a sin than it is for someone who is based in Denmark, where I’m from, that represents only 1 or 2% of the world-equity markets. Where I’d tell you you’re going wrong is you should diversify beyond the US, and you’re not doing that.

Only ~1 % of global equities in Danish stock market

Michael:          So I’m a complete hypocrite on this front. I worked in emerging markets so I professionally, on Wall Street, worked in non-US markets. Whenever I speak to friends, I say, “If you’re completely exposed to the US, you’re doing it wrong.” And nobody who grew up in any other country but the US would probably ever dare to be so bold as to only invest in their own country. It’s an irony.

Lars:                It’s interesting you say that, if I could just interrupt you there; you look at institutional investors in the UK or in Denmark, really any country in the world, and a lot of them will have exposure to just their own domestic stock markets, for lots of terrible reasons.

I’m saying that is generally a mistake, but in your case, it’s less of a mistake than if you lived in Denmark. If you lived in Denmark you would only have exposure to 1% of the world equities, where in the US it’s more like 35-40%. When I tell people to go buy the world-equity portfolio, you already have 35-40% as opposed to in Denmark you’d have 1-2% of that, so that is a big difference.

Michael:          Getting extremely practical, how many different positions in either ETFs or mutual funds do I actually need to buy if I’m going to get some kind of efficient frontier of global equity exposure?

Lars:                You can do just one.

Michael:          There’s a single ETF?

Lars:                The reason I’ve refrained from endorsing just one specific security is because I’m hoping that world-equity markets is a race to the bottom in terms of fees product. Right now, that might be called MSCI All Country World. Personally I don’t care what the index is called because what we’re after is the broadest, cheapest exposure. If someone comes up with a cheaper, better index, that’s even better. If an index-tracking product is cheaper and better, that’s even better. But you can buy the MSCI All Country World in one ETF, iShares will do that, DB Trackers will do that, Lyxor will do that. Vanguard does a version of it.

Michael:          I was going to ask: I use Vanguard because of their brand name, and low cost, passive mutual fund investing.

Lars:                They’re very good.

Michael:          They have this global, total world-equity exposure. Are there another half-dozen US fund companies who also –

Lars:                Yeah all the large ETF providers will have it.


This idea that you have your house, your education, your pension, all your assets come together and really are correlated to the same thing, which is typically your local economy. So one example I have in my book is imagine you’re a London-based real estate agent and you have your own flat. And you have a pension with the real estate agents, and then on top of that you own a couple of real estate related stocks in the UK.

Now, you are really long in London real estate market and that’s crazy to do that in your investment portfolio when you’re already so long in the rest of your investment life. This is yet another reason you’ve really got to stay diversified in your investment portfolio. Even sometimes your future inheritance is going to be in the same stuff: your parents’ house, your spouse’s job, dependent on the same local economy, your future job prospects dependent on the same local economy. Don’t have your investments in that same area.

This argument actually works better outside the UK because you can apply it to ‑‑ instead of London real estate I say Denmark. So very easily don’t have your equity investments in Denmark because you’re already long in Denmark. I think that’s a hugely important part of why these kind of diversified products really make a lot of sense for a lot of people. And why I think it’s a great shame that people tend to have their equity investments and investments generally so close to where their other assets are. They really all can go badly wrong at once, and that’s exactly what you should avoid.

Michael:          We know from the 2008 crisis that all risk assets correlate almost to one. In extreme downturn – everything that is a risk asset goes down all at the same time. That was a very scary reminder of that. There is nothing that is at all risky that doesn’t drop in value in a crisis.

Lars:                You’ve got to diversify. Then you could also look at if you’re a Greek investor, your real estate, your future pensions, your house, your job, all that would go belly up at the same time. Meanwhile, the rest of the world was fine. Imagine you had Greek government bonds as your low-risk asset. If you’d also had the Greek equity market as your equity exposure, you really would’ve been toast. Don’t do that. You’re not getting additional expected returns to reward you for that.

I think that’s an area that’s very important that people don’t talk enough about. That frustrates me. Again, people don’t want to listen to it because there’s little money in telling someone to buy the world-equity index. No one is interested in that.

Michael:          As an emerging-markets guy, it’s clear to me that anybody with any kind of net worth in any of these countries which has experienced typically a currency devaluation or nationalization or national political crisis, anybody generationally who grew up in that who has any net worth, always has a significant portion of their assets in Europe or the US or hard currencies. But in the US we don’t have an experience of having our credit – of course it’s been downgraded in the US but it’s not been junk status.

Our currency has never devalued wildly or unexpectedly. People are quite complacent about the idea of our exceptionalism. I’ve often said ‑‑ you said you wrote this book in a sense for your mom. I’ve often had conversations with my mom along these lines of do you know that most US investors have never considered that their house, job, currency exposure, government credit exposure is all US based? With almost no diversification. And we’ve gotten away with it up to this point, but it doesn’t mean we will in the future. It’s imprudent but as you say, people continue to do it because it’s either complicated, seems hard, boring, or not enough people are telling them to look elsewhere.

Lars:                No one is really incentivized for you to do that. No one makes money. The CFAs or financial planners don’t make money from this. What we’re talking about is not a good thing for the financial-planning industry either.

Michael:          It’s a much lower fee situation.

Lars:                Much lower fees, and paid by the hour kind of stuff.

Michael:          For the typical ‑‑ my orientation is the US investor ‑‑ the typical US investor, it will sound like madness when you say exposure to every equity market such that two-thirds of your money will be exposed to non-US will sound very aggressive to the US market. It doesn’t sound aggressive to me. It sounds like an obvious, logical outcome of the efficient-market hypothesis, just get the broadest exposure. But it will sound aggressive. You mean you’re going to put 65% of your net worth in non-US?

Lars:                You’re going to own Indonesian stocks? Where’s Indonesia?

Michael:          It sounds very aggressive. It sounds less aggressive to anybody who doesn’t live in the US, because they’re used to that.

Lars:                That’s right, I couldn’t agree more. This book actually shouldn’t but it’s going to be an easier pitch outside the US because you’re already likely to have exposure to non-domestic securities or at least you’re going to be accepting of the possibility that you should.

Michael:          In currencies and government exposure, and all of that.

Lars:                That’s why all the best FX (foreign exchange)  traders are all Argentine. They grew up ‑‑ my college and business school roommate is from Bolivia. He said the one time in his life his mom ever hit him was when he was a kid and he’d gotten some US dollars. He had to run down to the bank and exchange them. Or he had some bolivar or whatever it’s called. He ran down and exchanged the US dollars. He came across a [soccer] pitch and a bunch of guys were playing football,  so he played football for two hours and then he went to exchange it. The amount of money that had cost in the currency…

Michael:          Poor kid.

Lars:                You learn about inflation real quick.

Michael:          Tough lessons about inflation.

Please see related post, a book review of Investing Demystified, by Lars Kroijer.


Please also see related podcast post, Interview Part II – Do you have an ‘edge’ when it comes to investing?  We doubt it!  Also, a description of  Kroijer’s previous book Money Mavericks: Confessions of a Hedge Fund Manager

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