Why Invest Internationally?

Like most citizens of the United States, I had always thought of the U.S. stock market as “The Market.” And I can remember the efforts we made at the big Boston investment house where I used to work to get people to allocate a small amount of money to non-U.S. equities, which mostly meant Europe at the time.

Now, with exchange-traded funds, Standard & Poor’s Depositary Receipts, index funds and American Depositary Receipts offering instant exposure to every imaginable country, region, sector, industry and index, investors have every reason to be much more cosmopolitan.

So are they?

Investment advisors say that about 30% of an individual’s equity portfolio should be in international stocks. Yet, research has shown that many individual investors (one out of five) think that they should have 10% or less of their stock portfolios in international (outside the U.S.) equities.

Why is this?

I think that part of the reason is familiarity. In automotive stocks, people in the U.S. know Ford (F) better than they know India’s Tata Motors (TTM). (And Ford actually outperformed Tata in 2009.) But people also know Google (GOOG) better than they know China’s search giant Baidu (BIDU), and Baidu outperformed Google by a wide margin for the year.

The other reason, I suspect, is a kind of patriotism. U.S. citizens want to invest in U.S. stocks because they feel a kind of loyalty to the U.S. and identify with its companies more completely.

It’s a reaction that leads many people to make “Buy American” their first priority, whether they’re buying stocks or cars or consumer goods. (And by the way, it’s also the same reaction that leads Indian investors to their enormous preference for Indian stocks.)

There’s nothing wrong with patriotism, but if taken too far, it can become damaging. Refusing to diversify a stock portfolio can lead to outsized losses. Plus, the opportunity risk of avoiding international and emerging market equities (which have outperformed U.S. stocks in the last couple of years) is substantial.

Of course I’m prejudiced myself because I write Cabot Emerging Markets Investor, and despite the recent dip in Chinese stocks, the Report is still the top-performing newsletter of all financial newsletters for the past five years.

But part of being a patriotic American is embracing the capitalist ideal that has helped to make the U.S. a world leader. (I recognize that capitalist excesses also caused us to shoot ourselves in the financial foot, but the principle stands.) And the rational capitalist finds the most advantageous investments available, subject to risk tolerance.

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