Guess what? You’re biased.
No, I’m not talking about your preference in the age-old debate of Coke (KO) vs. Pepsi (PEP). What I’m talking about is your propensity to favor U.S. stocks over international stocks.
Market pundits have dubbed this phenomenon “hometown bias,” and that could be costing you some serious money over the long term.
That’s because the U.S. simply isn’t as big as it once was when it comes to the stock market. There’s more out there than just the equities of the S&P 500.
And as a younger investor, you probably have the best opportunity — based on your long timeline — to reap the rewards of going global.
America’s Role in Global Market Dwindling
According to research done by mutual fund sponsor Dreyfus, the average U.S. investor has just over 75% of their money locked up in U.S. stocks. That might not seem bad at first blush — after all, the U.S. is the biggest economy on the planet. However, it can actually be bad news for your portfolio.
The reason: The U.S. continues to see its leadership position dwindle as a percentage of the total world’s market capitalization. (That’s a fancy way of saying that there are more companies, and bigger ones, located outside the U.S. than in it.) This “total market cap” metric includes companies of all different sizes as well — large, mid- and small cap alike.
Back in 2000, American firms made up around 48% of the total world’s market cap. As of the end of 2012, that number has fallen to just 38% — the lowest percentage ever recorded. Meanwhile, the share of emerging-market nations such as China and Brazil has more than tripled in the same time frame.
In short, if you’re the average American investor, you’re putting the bulk of your money into a small and declining set of opportunities.
The problem of hometown bias gets even worse when you consider that American firms aren’t even the top dogs in their fields. You’re just as likely to drive a Honda (HMC), eat a Nestle (NSRGY) chocolate bar and use Bayer (BAYRY) aspirin as you are a similar American-based product.
Add in other favorable factors like higher dividend payouts, positive currency fluctuations and potential higher earnings growth overseas, and you have to really wonder what the bulk of U.S. investors are really doing by limiting themselves to our shores.
Longer term, these investors could really be hurting their portfolios as the U.S. continues to lose market share to foreign rivals.
Don’t Be Average
You shouldn’t just dump all your U.S. holdings immediately — far from it — but you absolutely should increase your exposure to international stocks.
A pretty painless way is through the Vanguard Total International Stock Index ETF (VXUS), which basically covers 98% of the world’s non-U.S. stock markets. That gives investors exposure to both developed nations (like European countries and Japan) and emerging nations (Russia, India), via countries large and small. Overall, VXUS holds a whopping 5,535 firms … and not one of ‘em is American.
Aside from that broad exposure, investors are treated to Vanguard’s commitment to low costs. VXUS only charges 0.16% in fees, or $16 per $10,000 invested, compared to 1.33% for the average fund that tracks similar benchmarks.
Another compelling option is the iShares Core MSCI EAFE ETF (IEFA). The underlying EAFE Index — which stands for European, Australasian and Far Eastern — is the gold standard when it comes to large-cap international stocks, and handles around $1.4 billion in assets.
IEFA holds 2,511 stocks, including many international heavy hitters and well-known names like oil company BP (BP) or pharmaceutical giant GlaxoSmithKline (GSK). This focus on large-cap developed names has helped IEFA post solid gains for rock-bottom expenses of 0.14%.
Finally, if American investors are underexposed to international large caps, then they’re downright poor in small caps. Just like their U.S. counterparts, global small-caps have much greater breakout potential.
Tapping the opportunity is the SPDR S&P International Small Cap (GWX), which tracks developed-market international stocks with market caps under $2 billion. GWX features 1,188 different international small-caps from places like the U.K., Japan and the Netherlands. All for just 0.59% in expenses.
By limiting yourself to just the U.S., you’re doing a major disservice to your portfolio. The time to get more global is now, and there are plenty of low-cost ways to do just that.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.