Staying close to home and surrounded by familiarity may be comfortable, but investors should think twice about using the same strategy for their portfolios. Concentrating your investments in any one region or home country can lead to excessive risk and missed opportunities.
The concept of “invest in what you know” may hinder returns for the average retail investor. If your portfolio is always heavily weighted toward domestic markets and you tend to ignore any investment opportunities simply because they’re located outside the United States, you may have a case of home country bias. Side effects include: a non-diversified portfolio, increased risk, and opportunity cost.
“The antidote for these biases is to try to build a diversified portfolio; one that does not over represent your local region or home country. Unfortunately, many investors continue to focus too much of their investment locally, often rationalizing the habit by pointing out that diversification didn’t work so well during the financial crisis,” explains Russ Koesterich, BlackRock Chief Investment Strategist. “It’s certainly true that almost every asset class, with the exception of U.S. Treasuries and gold, moved together for a period of time during the last crisis. But that’s the exception that proves the rule. Diversification is not likely to, nor is it intended to work over short-time periods, particularly when those periods are characterized by a financial crisis.”
It’s quite easy for Americans to fall victim to the home country bias. We have the largest economy of any nation, backed by the world’s largest military and gold stockpile. However, even though many American companies have international revenue streams, the U.S. stock market only accounts for a little less than half of the world’s equity valuation, according to recent data from Bank of America Merrill Lynch. Other regions such as Europe, United Kingdom, Japan, and the Emerging Markets also play a notable role in equity markets that should not be so easily overlooked. Fortunately, it’s now easier and cheaper than any other time in history to diversify.
The rise of exchange-traded funds over the past decade has provided investors with a low-cost method of receiving exposure to foreign markets. In fact, there’s practically an ETF for any region or country you can find on a map. The Vanguard Total World Stock ETF (NYSE:VT) holds a mix of public companies across North America (53 percent), Europe (24 percent), Pacific (14 percent), and Emerging Markets (9 percent.) Meanwhile, iShares by BlackRock offers ETFs to target individual countries such as the iShares MSCI Brazil Index (NYSE:EWZ) or iShares S&P India Nifty 50 Index (NASDAQ:INDY).
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