Why Investors Should Keep Home Bias Out of Their Portfolios

In sports, supporting the home team can be a rewarding experience that brings together fans from all walks of life.

In investing, a similar sentiment often manifests in portfolios in what is known as home bias: the tendency to favor domestic equities over international equities.

A recent analysis by SigFig found that the median investor has 61% of their portfolio in domestic equities, and just 6.6% in international equities. (The rest is other asset classes, including fixed income, cash and cash equivalents, REITs, etc.) Yet, U.S. stocks represent just over 35% of the global equity market — which means that international publicly-traded companies represent two-thirds of the world economy, at least as far as market capitalization is concerned.

One of the main factors behind home bias is a preference for investing in what you know, and avoiding what you don’t. “There is a mindset of buying stocks you are familiar with,” says Sheryl Garrett, a financial planner and founder of the Garrett Planning Network. “Well, that’s really hard to do when you’re thinking of investing internationally. We might be familiar with Swiss chocolates, European vacations or German cars, but we don’t know much about companies in even developed countries, and particularly in underdeveloped countries.”

Ironically, while ignoring international exposure might make an investor feel safer, its effect on a portfolio’s volatility is quite the opposite. Because international markets don’t necessarily move in the same direction as the U.S. market, adding international exposure to one’s portfolio would lower its riskiness, not increase it.

 

Affluent investors have less home bias

Not everyone is equally averse to international stocks. In SigFig’s data analysis, portfolio size was a key differentiator in how much exposure to international markets investors have.

home bias chart .001

Simply put, the larger a portfolio, the larger its international exposure. While the median international equity share of portfolios between $20,000 and $100,000 was 6.4%, that of portfolios between $100,000 and $400,000 was 8.4%. Portfolios of $20,000 or less had just 0.5% in international equity.
 

So do Millennials and Gen X-ers

Whether it’s growing up in the age of the Internet, entering the workforce when collaborating with global teams is par for the course, or they simply have more tolerance for risk (or what is perceived as risky, anyway), investors who are 20 to 39 years old have significantly more international exposure than investors who are 60 and older: 12.2% vs 8.1% of portfolio, respectively.

Another possible reason is that older investors are simply less familiar with international equities, says Stella Huh, a data scientist at SigFig. “They were born in and lived in a time when the United States dominated the world economy.”

 

Keep your eyes on the long-term prize

Taking a disciplined approach is hard, especially when you compare how the US stock markets have performed in recent years to those overseas. The S&P 500 gained 11.39% and 29.60% in 2014 and 2013, respectively (not including dividends), while in the same years, the MSCI Emerging Markets Index was down -2.2% and -2.6%.

There are, of course, legitimate concerns with international investing: political uncertainties, accounting irregularities, corruption, and conflict. That’s normal. However, Garrett argues, countries behave much like companies: one country that used to be an emerging economy is now developed, and now others are coming along. “There are always going to be bad parts of the world that will be challenging, but that doesn’t mean that we should ignore them,” she says.

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So how much of a portfolio should be in international investments? Depending on an individual’s age, net worth, risk tolerance and other circumstances, SigFig’s Head of Research and Wealth Management Aaron Gubin recommends that investors hold at least 50% of their equity positions in international investments. “The markets are making a judgment call where to put their money,” he says. “And global markets are saying, 60% to 65% of our money should be in the rest of the world.”
 

This article was originally published on US News & World Report.
Aleksandra Todorova
Aleks Todorova is the Editorial Director at SigFig.

The Greek crisis, startups staying private, and investor home bias

1. The Greek crisis is in the headlines. If you are just catching up, here is a terrific explainer from Vox.

How did we get here?

The roots of Greece’s crisis are simple. Before Greece joined the Eurozone, investors treated it as a middle-income country with poor governance — which is to say, a credit risk. After Greece joined the Eurozone, investors thought that Greece was no longer a credit risk — they figured, if push came to shove, other Eurozone members like Germany would bail Greece out. They were wrong.

What does it mean for Greeks?

Greece’s problems are often framed as a financial crisis, or a political crisis. But what they really are is a human crisis. Unemployment in Greece is over 25 percent now — higher than the United States during the Great Depression. And high unemployment is leading to political backlash.

2. What will happen with a Yes or No vote in the Sunday referendum? The Economist describes the scenarios.

3. What’s the next big tech IPO after Fitbit? One may have to wait. The New York Times shares how today’s startups stay private for longer:

For start-up entrepreneurs and their employees across Silicon Valley, an initial public offering is no longer a main goal. Instead, many founders talk about going public as a necessary evil to be postponed as long as possible because it comes with more problems than benefits.

4. The Times has a round-up of robo-advisors, focusing on services targeted at high net-worth investors.

5. We offer a column on investor home bias, and wish our readers a happy long weekend.

 
 
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SigFig Portfolio Growth Projection Chart Update

SigFig team updating the portfolio growth projection chart to reflect the median (i.e., 50% outcome) correctly. The projection chart on our site listed the mean outcome of a Monte Carlo portfolio simulation instead of the median outcome. This does not reflect any inaccuracy in terms of model portfolio composition or trading of client accounts.
 

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The SigFig Team
Announcements, news, and updates from SigFig.
The Editors
Aleks Todorova

Aleks Todorova

Editorial Director

Aleks runs content at SigFig. Before joining the company, she ran the editorial teams at Visually and Mint.com. Her work has appeared on SmartMoney.com and the Wall Street Journal, among others. At lunchtime and on weekends, you'll find her swimming, biking or running -- or all three, in that order.
Benny Wijatno

Benny Wijatno

Data Science and Analytics

Benny does all things data and science at SigFig. He was Director of Product Analytics at TinyCo and a Principal at Applied Predictive Technologies, where he helped companies run smarter experiments. He studied Economics at Harvard, is an avid cook, and loves running.