Am I Diversified Enough?

“It may seem counterintuitive, but if you have something in your portfolio that you’re complaining about, it’s a good sign you’ve built a diversified portfolio.” – Carl Richards

Common sense reader mailbag: I live in Canada and currently have about 20-25% of my portfolio invested in Canada with the rest spread over other global markets. Do I need to invest more globally? Do I have too much invested in Canadian investments?

This is a great question because I think it’s very important for investors to have a globally diversified portfolio. You can gain access to different economies, regions, countries and companies along with a diversified stream of returns.

You also get to use the benefits of rebalancing from the stronger markets to the weaker markets over time so you can consistently buy low and sell high. Historically, this has added to your investment performance while also giving you a smoother ride than only investing in a single market or region.

Before I answer this question, here are a few interesting studies, facts and figures on this topic from Jason Zweig of the Wall Street Journal:

  • Investors in France have over 50% of their money in French stocks (French stocks make up 3.2% of the world stock market capitalization)
  • New Zealanders have almost 75% invested in their home country (New Zealand has less than 1% of world market cap)
  • Greeks keep over 90% of their investments in Greece (less than 1% of world market cap)
  • US investors have about 5% of their stocks in foreign investments (US has 34% of world market cap)
  • Before the Japanese stock bubble burst in the early 1990s, Japanese investors had 98% of their money invested in domestic companies.
  • One study showed that German investors expected their markets to beat US markets by 2-4% per year while US investors expected their markets to beat the German markets by the same margin.

As you can see there is definitely a home country bias for investors. The biggest reason for this is the fact that it’s much easier to invest in markets that you are familiar and comfortable with. The same reasoning leads investors to hold too much of their own company’s stock even though that’s a risky proposition.

This is not just a hunch on my part. There are studies that prove this point. One neurological study showed that when investors considered putting their money into foreign markets, part of the brain’s fear center immediately kicked in. Your brain actually tells you that it’s scary to invest in international markets that are out of your comfort zone.

BACK TO CANADA
To get back to the question at hand, Canada makes up only about 3.4% of worldwide stock market capitalization. On the other hand, Canada has the 11th largest economy in the world, so many of their companies are global in nature.

There’s no right or wrong answer on the subject of how much to invest outside of your home country. You need a solid balance of investing where you are comfortable and diversifying globally.

My unscientific answer would be that you should probably have enough of your investments outside of Canada that you are slightly uncomfortable, but not enough that you will abandon your diversification at the first sign of losses in foreign markets.

Since you already have 75-80% of your portfolio invested outside of Canada I think you are on the right track.

HOW TO MAKE THE CHANGE
For those that determine that their portfolios are too heavily weighted to their home country’s markets, there’s no need to panic and immediately make the switch to foreign markets.

Take your time. Figure out a balanced international allocation and gradually rebalance your portfolio to hit your new target weighting. You can do this on a periodic basis (maybe monthly or quarterly) or on a more tactical basis by shifting to those markets that are underperforming at the moment.

That way you gain the benefits of dollar cost averaging to ease yourself into the global diversification process and don’t freeze up at the first sign of trouble in foreign markets.

There are many ways to diversify outside of your home country’s markets. Diversified funds are now available in many forms:

  • All-world markets
  • Foreign developed markets
  • Emerging markets
  • Regions of the world
  • Country markets

Funds can also be broken out by the size of the companies (large, mid & small) or even investment strategies (dividends, growth, value, etc.) for each different market so you have plenty of options.

Sources:
Seeking Alpha
Your Money or Your Brain
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