After a US Stocks fund and a bond fund, the next most important addition would be an international fund.
The United States makes up about 40% of the total world economy. The largest companies in the United States are more likely to be worldwide companies though – ones that benefit from consumers all around the world. Think Coca Cola, McDonald’s and other companies that are global names. They’re US companies, but they aren’t only selling to US consumers.
The other 60% of the world economy comes from everywhere else.
The size of the US compared to each individual country’s market is huge, but compared to all of them together the rest of the world is huge!
If we want to be globally diversified and benefit from the entire world’s economy, we’d need to invest some outside of the United States. If you invest purely in the United States, you’re making a bet that the United States will continue to outperform every other country in the world.
Meb Faber, an investment advisor who also runs a fund, has a really great Twitter thread about international investing. I’d encourage you to read through it all because it has some great points. I’ll touch on some of the big ones here:
- Global indexes, like the MSCI All-World Index, invest about half their investments outside the US.
- Investors in most countries tilt their portfolio to their home country. It’s called “home country bias” – a belief that our home country is best. (That doesn’t mean it’s right)
- Investing out of proportion with the world market is a bet on that area outperforming the rest of the world.
- The Shiller PE Ratio measures the ratio between the price of a market and the earnings delivered by that market. The higher the PE ratio, the more overpriced the market. The US market has a MUCH higher PE ratio than international markets.
This visual from Meb Faber’s Twitter thread explains a lot:
In the 1980s, if you had only invested in the US, your portfolio would have only done HALF as well as if you had a portfolio weighted by the size of each economy. In the 90s a US portfolio would have done better. In the 2000s it’s back to a weighted one and in the last decade, the US portfolio wins handily.
What does that mean for the future? Well, for one it means that historically the US hasn’t always been the best performer. Also, it means that a diversified portfolio has had positive returns, even when the US hasn’t. If we go farther back, the US has underperformed an equal weighting in 8 out of 12 decades. 8 out of 12!
In other words, it’s historically been a good thing to spread your investments around the world.
As for how much you put where a good guideline is to weigh your investments based on the global market. That would put 40% of your investments in US funds, and 60% in international funds.
I usually flip that and do 40% international and 60% US. I base this on the idea that most US companies are international – more so than the economies of any other country.
If you were to do that, here’s what your portfolio would look like, assuming 20% bonds.
| Sector | Amount |
| US Equities | 48% |
| International Equities | 32% |
| General Bond Fund | 20% |
| Fund | Amount |
| $VTSAX – Vanguard Total US Market or$VFIAX – Vanguard S&P 500 | 48% |
| $VTIAX – Vanguard Total International Fund | 32% |
| $VBTLX – Vanguard Total Bond Index | 20% |
How much you allocate to international funds is dependent on how much you want to skew your portfolio towards the US.
Ok, all the key points in this lesson focus on investing internationally.
#1, there’s a big world out there beyond the United States! If you invest in funds just within the United States, you’re only investing in about 40% of the world economy. You lose out on global diversification and risk lagging returns.
#2, a portfolio with international funds would have outperformed a portfolio of only US funds 8 out of the last 12 decades! US funds have done extremely well for the last 10 years – there’s no doubt about it. But I wouldn’t plan for that to be the case in every decade.
#3, using the Cape Schiller Index we can measure the value of a market by taking into account the cost and how much revenue it generates. By that measure, we pay more to invest in the US market than anywhere else in the world.
By adding international funds to our portfolio, we help diversify it while also prevent home-country bias. Most of the sample portfolios we’ll look at later in this course use international funds for exactly this reason.