20%. 40%. 60%. More?
Allocation of your portfolio to international stocks and be a tough decision make. Even financial professionals don't have a consensus on what an investors allocation to International stock should be.
Big Investors That Like US Only Stocks
2 big name investors make it clear that they don't like international stocks and advise investors to invest only in US equities. The first is Jack Bogle, the founder of Vanguard. He expressed "You have an international portfolio, why do you want a larger one?" referencing the fact that the S&P 500 derives substantial revenue and earnings from other countries. He's also very optimistic on the US economy as whole stating "we have this fabulous economy here. I mean yes it has problems, but probably less problems than any country in the world." Both of these statements were on the Masters In Business Podcast.
The other is Warren Buffet. He recommends a portfolio of 90% S&P 500 index fund and 10% in short term bonds. Glaringly omitting international equities, he has advised the trustees who will manage his wife's investments after his death.
Recency Bias Favors US Stocks
One thing most novice investors do when they consider making any investment, is look at the cumulative growth of $10,000 over the last 10 years.... because clearly whatever has done best for the least 10 years will do just as well going forward 🙄. It's a common novice mistake.
And when we look at that chart 10 year chart we can see why many investors would rather just omit international equities altogether.
Here we can see just how great US stocks have done relative to international stocks. A $10,000 investment in the S&P 500, using the Vanguard S&P 500 mutual fund VFINX, would have grown to $37,338 for a 273% return. Holy smokes. Mean while international stocks basically went no where. A $10,000 investment in the MSCI EAFE index, using the iShares EFA ETF as a proxy would've grown a measly 75.04% to $17,504. The other line on the low side of the chart is emerging markets. We'll talk about those later one.
The Argument Against International Stock: US Stocks Have Substantial International Revenue
One of the big arguments against holding international stocks is that US S&P500 has substantial revenue and earnings outside of the US. This is true.
This chart by S&P global shows the revenue breakdown by country of the S&P500. About 29% comes from countries other than the United States (source).
Perhaps some investors might feel that is equivalent to 29% international stock equity. I'd disagree though as US stock indexes and International stock indexes often have wildly different valuations.
The other Argument: International Stocks Have Outperformed US Stocks
We've already seen that is true for the last 10 years, but it is not always true.
Take a look at this chart that shows the annualized returns for each of the last 5 decades for Bothe the S&P 500 and the MSCI World ex USA Index.
In some decades, international stocks do out perform us Equities. And no one really knows what the future holds.
International Stocks Are Currently At Much Lower Valuations
While US stocks do generate revenue in other countries, that revenue(and earnings) are valued relative to other US stocks.
This chart by Siblis research shows the Cyclically Adjusted Price To Earnings (CAPE) Ratio of US Stocks to Global Stocks. It is important to note that the Global CAPE Ratio displayed in this chart includes US Stocks as well.
Notice the difference between the CAPE Ratio of US and Global stock? The Global CAPE is much lower than the US. Now consider that includes US stocks. If we were to look at the Global ex US CAPE Ratio, we would see that international stocks are at valuations about 50% lower than US stocks.
While US Stocks currently have higher valuations than international stocks, there's no rule that says this must be the case. In other periods historically, international stocks have had higher valuations, as we can see in the late 80s.
What Is The Global Market Cap Weighting of International Stocks
This one is for the pure Bogleheads that like to stick to passive market cap weighting!
We can look at Vandguard's Total World Stock Market ETF VT to see about the current market cap split between US and international stocks. Right now it sits at around 60% US, and 40% international.
The US to international market split has varied overtime as we can see from the chart below.
My Owner Personal Preference On International Stocks
So what do I personally think about international?
My thoughts come not from the returns but from the properties and correlation of the asset classes themselves. US Stocks have displayed lower volatility throughout history, possibly due to be regulation and transparency in the market. At the same time, correlation among US stocks and international developed stocks has increased (that globalization thing).
This data shows the correlation of the S&P 500, International MSCI, Emerging Markets index using ETFs as a proxy since 2001, based on monthly returns.
International stocks had a correlation to the S&P 500 of 0.87 -- pretty strong. Less correlated was emerging markets.
Also consider that emerging markets currently have a cape ratio about 50% less than the S&P 500 -- even lower than broad international markets.
To me this makes emerging markets specifically appealing as a holding for international stocks.
In my 3 Fund Portfolio, I like to hold 25% of the equity allocation in emerging markets. I have a video on this here: Corey 3 Fund Twist Portfolio