According to Morningstar, U.S. mutual fund investors held, on average, only 27% of their total equity allocation in non-U.S.-domiciled funds as of year-end 2013. This represents small allocation to international stocks when we consider that more than half of the value of all stocks worldwide are tied to companies based outside the United States.

While there’s no one size fits all investment and some home bias can be justified, there are a few reason we believe most long-term investors benefit from broad international diversification:

  • Performance. U.S. equities and international equities tend to alternate as top performers over time. Choosing 100% U.S. stocks because of recent returns is essentially an attempt to chase performance, which has often been ultimately unsuccessful.
  • Volatility. Despite the 24-hour news coverage of political and economic instability across the globe, a complete avoidance of foreign equities is not likely to lower portfolio volatility. Instead, allocating part of a stock portfolio to international markets has historically reduced volatility relative to a 100% U.S. stock portfolio.1
  • Multinationals. Holding stocks of multinational companies does provide foreign market exposure; however, it doesn’t offer the same level of diversification as an allocation to international equities. There are several reasons for this.
First, although it’s true that large U.S.-domiciled multinationals generate a significant portion of their revenue outside the United States, a company’s performance has historically correlated more highly with the performance of its domestic market than with that of any region in which it conducts business.

Second, foreign currency exchange can be a strong diversifier, but this benefit isn’t realized through holding multinational equities because most firms hedge away the currency fluctuations of their foreign operations.

Finally, it’s important to realize that the sector exposures of the U.S. and international equity markets vary significantly, creating a gap not bridged by multinational stocks.

U.S. and international stock markets

The Industry Classification Benchmark (“ICB”) is owned by FTSE. FTSE does not accept any liability to any person for any loss or damage arising out of any error or omission in the ICB.

How much international investments should you have?

While there’s not a universal rule that works for everyone, we believe a 20% allocation to international stocks is a good starting point for most investors, balancing diversification benefits and risks such as currency volatility. For investors who are less concerned with risks and/or higher costs associated with international investments may find an allocation closer 40% more suitable.

For more information on the potential benefits of international stock diversification, please read the following Vanguard whitepaper, Global equities: Balancing home bias and diversification.

Christopher B. Philips, 2014. Global equities: Balancing home bias and diversification. Valley Forge, Pa.: The Vanguard Group. This source supports all information in the article, unless otherwise noted.

All investments are subject to risk, including the possible loss of the money you invest.

Diversification does not ensure a profit or protect against a loss.

Investments in stocks issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.