What Your Investment Portfolio Is Likely Lacking
A study finds people 50+ are light on foreign stocks. Should you bulk up?
The U.S. stock market has had another great year so far (mostly) and, if you have a 401(k) or an IRA, odds are you’ve profited nicely. But if you’re 50+, there’s a good chance you’ve missed out on gains from international stocks.
According to a new study I learned about at the Retirement Research Consortium meeting recently, “older people are consistently less internationally diversified than younger people.”
Said Columbia University professor Enrichetta Ravina, one of the authors of the paper (Who Is Internationally Diversified? Evidence From 296 401(k) Plans): “People born before 1950 tend to invest way less internationally than those born after 1980.”
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Older 401(k) Investors vs. Younger Ones
In their paper, Ravina, her Columbia colleague Geert Bekaert, and Kenton Hoyem and Wei-Yin Hu of the investment advisory firm Financial Engines studied 401(k) investment patterns of more than 3 million people between 2006 and 2011, breaking them into age groups: 64 and older; 55 to 64; 45 to 54; 35 to 44 and 34 and younger.
They discovered that the older the age group, the less the international diversification in their 401(k) plans. The youngest employees had nearly a quarter of their 401(k) holdings (24 percent) in international stocks, while those in their mid-50s and older only had about 15 percent.
There’s clearly an age difference for international stock ownership, though not a gigantic one. “It’s not as if older and younger investors are worlds apart, so to speak,” said Walter Updegrave, of RealDealRetirement.com.
Marc Freedman, author of the new book, Retiring for the Genius, and President and CEO of Freedman Financial, an advisory firm in Peabody, Mass. told me that a paucity of international investing is “very common among people I see in their 50s and 60s, especially if they are five to ten years from retirement."
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What Keeps Older Investors Away
Why are older investors light on international stocks?
“What’s probably going on here is familiarity,” said Bekaert, in a phone call from, appropriately, his native Belgium. “Investors prefer to invest in things they know. And the younger you are, the more plugged in you are to globalization. Younger people are more comfortable with all things foreign, including foreign investments."
By contrast, said Bekaert, people in their 50s, 60s and 70s “have lived in a pretty closed world.”
“Often we neglect to remember that there are many very successful global companies based outside the U.S.,” said Freedman. “Companies like Samsung, BMW, Volkswagen and Nestle.”
The Truth About Risk
Some older investors may have also shied away from foreign stocks thinking they’re too risky. Bekaert says they’re under a misapprehension.
“If that’s what they think, it’s very irrational,” he said. “You lower your portfolio’s risk by investing internationally.” To spread out your risk, said Freedman, commit to holding your international stocks for five years or more — seven to 10 years for stocks from developing countries.
And if you worry that money invested in an international stock fund or international account in your 401(k) could be wiped out, Freedman says: don’t.
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“That’s the disconnect a lot of people have with international investing. They think: ‘Oh my goodness, I could lose all my money!’ But that’s virtually impossible. Every stock in the portfolio would have to go to zero.”
Foreign Stocks Vs. U.S. Stocks
There’s no guarantee, however, that if U.S. stocks go down, international stocks will go up. The last market crash proved that notion to be a shibboleth.
In 2008, the U.S. stock market lost about 37 percent, foreign stocks (measured by the EAFE index of big companies from developed countries) lost 43 percent and emerging-market stocks fell 53 percent, said Updegrave. “Having foreign stocks in your portfolio isn’t likely to give you shelter during severe market crashes,” he said.
And putting international stocks into your investment basket doesn’t ensure that you’ll boost your portfolio’s overall return — although foreign stocks have performed quite well over the past year (up 12.4 percent, on average) and the past three years (up 9.2 percent a year, on average).
“There have been periods when you’d have been better off putting all your money in U.S. stocks, like in the roaring market of the 1990s,” said Bekaert.
In a fascinating Wall Street Journal piece recently, Updegrave had Morningstar construct hypothetical portfolios with varying degrees of diversification over the 20 years ending June 30, 2014. The 70 percent U.S. stocks/30 percent U.S. bonds portfolio slightly outperformed a similar portfolio that also contained foreign stocks: an annualized 9.1 percent vs. 8.7 percent. But over the 10 years ending June 30, 2014, the one with foreign stocks did slightly better than the one without: 7.9 percent vs. 7.6 percent.
That said, a Reuters article recently noted that, according to a study by investment managers Gerstein Fisher, a globally-diversified portfolio outperformed a U.S.-only portfolio in 96 percent of rolling three-year periods between 1999 and 2011.
The Outlook for Foreign Stocks
And looking into the future, “many international economies, especially the emerging market economies, have far higher projected growth rates than the United States,” writes Peter Mallouk in his new book, The 5 Mistakes Every Investor Makes.
Some analysts (including Bekaert) think the U.S. market’s 2014 runup makes this a particularly good time to diversify into international stocks. “I find the U.S. market somewhat frothy right now,” says Bekaert.
Doug Ramsey of The Leuthold Group investment firm recently told Ychart.com’s Carla Fried that “the United States’ large P/E [price-earnings ratio] premium relative to the rest of the world suggests that foreign equities should produce total returns of about two percentage points [annualized] above the U.S. over a seven- to 10-year horizon.”
How International Should You Get?
Exactly how much of your portfolio belongs in international stocks — ideally through a diversified global fund or 401(k) account — is a personal decision.
Updegrave believes that, as a rule, if 15 to 25 percent of your equity allocation is in foreign stocks “you’re probably getting a good deal of the benefit that international diversification has to offer.”
Freedman agrees. He generally recommends allocating 20 percent to international stocks, with a quarter of that in stocks of developing countries such as China, Vietnam and Russia. “I’m much more comfortable with developed countries,” he said, because they are regulated more like those in America.
But, added Freedman, “if you don’t think you’ll sleep well owning international stocks, don’t even think about doing it.”