Trading the World

A stubborn investing rule shared by Jack Bogle and Warren Buffett

Elizabeth MacBride, special to
Key Points
  • U.S. investors hold, on average, 15 percent exposure to stocks outside the U.S.
  • The percentage of products and services produced or sold by S&P 500 companies outside the U.S. declined in the past decade.
  • The S&P 500 is trading at a significantly higher multiple than international developed markets and emerging markets indexes.
Frederic Brown | AFP | Getty Images

Investment legends Jack Bogle and Warren Buffet have a few things in common: They embrace low fees and index investing, and millions of people look to them for investing wisdom. One other thing: When it comes to investing, both are homebodies.

Bogle dismisses international diversification. Buffett, meanwhile, says an index fund portfolio of 90 percent S&P 500 and 10 percent Treasurys is probably good enough for most investors — that's how he is recommending his wife invest. But the anti-international stance is the rare piece of investment advice over which many people dare to disagree with Bogle and Buffett.

"I would tend to disagree," said Omar Aguilar, chief investment officer of equities for Charles Schwab Investment Management, who hews to the basic idea that the more diversification, the better. "Maybe I am not a great investing mind!" he added with a laugh.

Bogle and Buffett don't cast this advice as stone-cold or research-driven. In fact, both say it is more a preference and perhaps geared for investors who need to keep it simple rather than those who want to generate the absolute highest returns for the lowest risk. Diversification is crucial for long-term investors because it tamps down risk, and Nobel Prize-winning science says the more, the better — if you don't pay too much for it.

The crux of the case for not worrying about international diversification has always been that the multinationals that make up the S&P 500 generate a signification portion of their revenue from international markets. Holding an S&P index fund, where multinationals like or are generating plenty of money from international sales, is a sort of shortcut to international diversification. Because an S&P 500 index fund is one of the cheapest investments around in terms of fees — the expense ratio on those funds is often under 0.1 percent — it's also a cheap way to diversify internationally.

But is that enough in a changing world? If you've been relying on the S&P to capture much of the globe's economic growth as you can over the long term, it could be time to rethink, say a growing number of experts and evidence.

The long-term fundamentals in international markets, especially in emerging markets, look good. Growing middle-class populations in Africa, Latin America, the Middle East and Asia are likely to propel some markets — most likely those with sound governance — to greater annual GDP growth than the United States.

After the eight-year run-up in U.S. stocks, international developed and emerging markets look like relative bargains and are currently among the world's hottest trades.

Stocks are relatively expensive, but will do better than bonds: Jack Bogle
Stocks are relatively expensive, but will do better than bonds: Jack Bogle

Tim McCarthy, author of The Safe Investor and former CEO of Tokyo-based Nikko Asset Management, said that in an increasingly uncertain world, investors looking for long-term growth with the lowest amount of risk possible should seize all their "diversification dimensions."

Some advisors or portfolio managers who opt for the S&P shortcut may be doing so in part because they lack the experience or resources to invest internationally: "To my mind, saying 'I get exposure only through buying the S&P' is like saying 'I get plenty of exposure, but I only buy company names that begin with A through M and don't buy any N through Z.' Why cut your universe of opportunities down so low?" said McCarthy, who has also held positions at Schwab, Fidelity Investments and for financial firms based in Hong Kong and Seoul.

Two of the broadest possibilities: Vanguard's VEA, a developed markets ETF with an expense ratio of 0.09 percent, and BlackRock's emerging markets IEMG, with an expense ratio of 0.14 percent.

To my mind, saying 'I get exposure only through buying the S&P' is like saying 'I get plenty of exposure, but I only buy company names that begin with A through M and don't buy any N through Z.
Tim McCarthy
author of "The Safe Investor" and former CEO of Tokyo-based Nikko Asset Management

Five factors suggest direct international investment is worth a look if you've been relying on the S&P, or even if you're invested in international index funds but may have become underweight in recent years.

1. Investors need to be more picky about international diversification. In recent years, U.S. stocks have been gobbling up more of the global stock universe, unseen by many index fund investors. The MSCI All Country World Index weighting represented by U.S. stocks grew from 54.3 percent in 2013 to more than 60 percent last year. The MSCI World Index weighting represented by the United States has also risen — from 48.6 percent in 2013 to 53.8 percent in 2016, according to MSCI.

When those markets boom, the upside can be tremendous. For instance, between 1998 and 2007, the MSCI emerging markets index generated an annualized 19.8 percent, according to Luciano Siracusano, chief investment strategist at New York-City based ETF asset manager WisdomTree. The past 10-year period have been a different story — the MSCI Emerging Markets Index ETF (EEM) is up roughly 1.5 percent, according to Morningstar data.

2. There's often an advantage to investing where other people aren't. "There's a behavioral aspect that creates inefficiencies in the market," Aguilar said. Investors who recognize opportunities to diversify internationally may have a leg up, because so many other competing investors have a home bias. Despite the size of non-U.S. markets, U.S. mutual fund investors (excluding institutions) hold, on average, only 15.6 percent of their total equity allocation in overseas stocks, according to Morningstar. That's broken down between 9.8 percent in developed overseas markets and 5.8 percent in emerging markets stocks.

3. The S&P 500 shortcut does not look as good anymore. The percentage of products and services produced or sold by S&P 500 companies outside the United States equated to 44.3 percent in 2015, the lowest level since 2006. It was down from 47.8 percent in 2014 and the 46 percent average from 2009–2013, according to S&P Dow Jones Indices. That trend looks likely to continue. Multinationals have increasingly been relying on financial engineering, such as share buybacks, to generate returns, while their investment in emerging markets is falling. Developing world investment by multinationals, such as new factories and infrastructure, shrank to $440 billion from $460 billion in 2014–2015, according to the U.N. Conference on Trade and Development. Continuing a long-term trend, African foreign direct investment fell 20 percent, to $70 billion from $90 billion, during the same period, according to UNCTAD.

4. The S&P shortcut doesn't provide exposure to small company stocks in international markets. Some of the highest returns (and highest volatility) are generated by small company stocks, especially in emerging markets. Holding the S&P as your strategy for diversification doesn't give you exposure to any of that upside.

5. Keeping all your eggs in a U.S. stock basket could overexpose you to risks in the U.S. market, which does look a little risky now.

"Given the high value of the present U.S. market, especially with most all the good political news priced into this market, with little of possible bad news, having all your equity money in the United States doesn't feel so safe versus having broader direct international diversification," McCarthy said.

Respected hedge fund manager Jeffrey Ubben of ValueAct recently returned more than $1 billion capital to shareholders saying the U.S. market valuation was too high for him to not make that move. The S&P 500 is trading at about 21 times trailing earnings, Siracusano said, compared with a 15 to 16 times earnings multiple in international developed markets, and a 13 to 14 times earnings multiple in emerging markets.

The 20th century — when Bogle and Buffett both came to own their respective corners of their investing world — was the American Century, with U.S.-based multinationals the kings of the global business world. The country was so dominant that holding its biggest companies' stocks was a justifiable proxy for holding the world. The question for the long-term investor in the 21st century is whether that will remain the case — and if not, what's the best, diversified portfolio to represent an increasingly level world?

By Elizabeth MacBride, special to