Chris Philips, CFA, a senior analyst in Vanguard's Investment Strategy Group, gave his opinion on Fitting International Stocks in a Portfolio from a U.S. investor’s viewpoint:
“We think that for most investors, a great starting point is 20%. You get a significant amount of historical diversification benefit. You get some exposure to non-U.S. stocks and the fluctuations of currency, of markets, of economies globally. We do believe that if you are so interested, you can extend that to maybe 30% or 40%, and we'd actually be comfortable going all the way up to maybe market-cap-proportional, which would currently be around 55%. But that 20% range is probably a great starting point for somebody to look at.”
From a historical Canadian viewpoint, diversifying up to 50% of your equity holdings to non-Canadian stocks has resulted in a significant reduction in volatility. Incremental reductions in volatility have been obtained by diversifying even further than 50% away from Canadian stocks (although some investors may be uncomfortable with the additional currency risk inherent with this strategy). In the graph below, historical 3-year rolling standard deviations are shown (vertical axis) for four hypothetical balanced index portfolios (rebalanced annually) with various allocations to Canadian, U.S. and International equities:
As can be seen in the graph above, in almost all periods studied, balanced index portfolios with higher allocations to U.S. and International stocks (Portfolios 2, 3 and 4) have exhibited lower volatility, relative to a balanced index portfolio comprised entirely of Canadian stocks (Portfolio 1).
There are a number of reasons for this large reduction in volatility, mainly:
Interestingly enough, the historical annualized returns (from December 1979 to June 2011) are almost identical for all four hypothetical balanced index portfolios, showing that a globally diversified portfolio has historically resulted in similar returns with reduced volatility (something all nervous investors would have been delighted with):