Once again this year, as they have for 30 years, international stocks are lagging behind the U.S. and Canadian markets. This may lead you to wonder why you should invest outside of North America when the returns have been so paltry.
It’s a more relevant question than ever these days with Brexit and other troubles in Europe, and a sharp slowdown in China.
An analysis by PWL Research Director Raymond Kerzérho shows that a portfolio split evenly between Canadian and U.S. stocks has consistently beat one that was one-third Canadian, one-third U.S. and one-third international stocks over the last 30 years.
This year, the North American portfolio has returned 9.8% compared to 8.3% for one including international stocks to the end of February. Over 10 years, North American stocks returned 13.8% a year versus 12.9% when international equities are included. For 20 years the numbers are 6.6% and 6.0% while for 30 years they’re 9.4% and 8.2%. One percentage point may not seem like a lot, but over long periods of time, it’s huge.
So why not just put your money into Canadian and U.S. index funds and forget about it? After all, you get exposure to foreign markets through the activities of North American multinational corporations, right?
Looking beyond historical returns
Many of the portfolios we see from new clients seem to reflect this kind of thinking. It’s a line of reasoning that makes sense only if you look at historical returns, but there are many other things to consider.
First, the U.S. market has been performing very well for many years and that makes it expensive compared to international markets. Indeed, our long-term returns projection (looking forward 40 years) has international stocks generating 7.3% annual returns on average versus 6.5% for Canada and 5.9% for the U.S.
More fundamentally, we can’t predict the future. Just because North American stocks have outpaced international stocks in the past doesn’t mean the pattern will hold in the years to come.
As for the argument you get international diversification through the foreign activities of multinationals, Raymond observes you are still exposed to North American economic and political risks, regardless of where a company’s operations are.
At PWL, we are firm believers you should diversify your portfolio as much as possible. The beauty of today’s investment world is that you can include the rest of the world at a very low cost thanks to exchange traded funds that come with inexpensive management fees.
Diversification is critical in bear markets
The way markets work is long bull markets where the markets are marching mostly higher, interspersed with sharp, scary bear markets where they plunge quickly.
It’s at times like those that being diversified across other markets around the world becomes especially important, not only from a practical point of view, but from a psychological one as well.
So, the question is why invest in only two of the world’s stock markets when you could have all 42 for almost the same price?