COVID-19 has put a lot of ‘active’ investors in interesting positions. In February and early March, I started hearing about people pulling money out of the market into cash/bonds and waiting for the big crash that has yet to occur for them. Many are still waiting to jump back in while the SP500 has nearly recovered from the initial drop at the end of February… Now I am not saying that the market will NOT crash again, but if you are doing monthly contributions to your TSP/Roth/other accounts, over time you
will statistically win out over trying to time the market.

After the drop, from March onward, chatter about gambling in options/”investing” in 1-2 week short positions has proliferated my space. From overhearing office discussions about what the next “sure winner” is, to Facebook posts about how NOW is the time to invest, followed by various Robin Hood referral links, these speculators popped up everywhere I looked.  It really reminded me of the crypto craze of ’17-18…and just like the crypto craze, these discussions died out as quickly as they started, with the market volatility absolutely destroying these self-proclaimed “active investors”.  On the flip side, many of us that continued with automatic contributions into the market have since come out ahead of where we were in February, but a lot of questions have now been popping up on what the current TSP fund balance should be as well as where new contribution money should go and ‘the market’ in general.

Because of that, today I want to talk about diversification – specifically in international stocks.  These are definitely part of ‘the total market’ and should be included in your portfolio in addition to various US only funds and indices. However, if you ask around the office, or even google search where you should invest, you will definitely see and hear the following advice:

“Just put it in an SP500 index mutual fund/ETF”
“Only the C/S funds matter for the TSP”
“International stocks are pointless, most US companies in the SP500 do overseas business anyways”
“The SP500 always outperforms international stocks”
“You don’t need the L fund because of its worthless exposure to international stocks”

I get it, we are working for the US government and, more specifically, the Department of Defense.  Patriotism is high and Europe/Asia/Africa are places we go to police instead of seeing them as viable economic options.  People look back at the last decade and see that, on average, developed markets have not fared as well as the US stocks and further cement that “home country bias” (yes, it’s a real investing term) in their heads.  However, that does not mean you should listen to these people! You should DEFINITELY consider investing in international stocks and equities.

To start, let’s put an end to the myth that the US companies do significant enough business overseas to ignore extra diversification.  Based on Morningstar data in 2018, the SP500 generated roughly 62% of their revenue in the US and thus 38% overseas.  Meanwhile, a broad ETF such as the Vanguard Total International Stock ETF generated 15% of their revenue in the US and a whopping 85% overseas – or a difference of 47%… That is HUGE!  Additionally, international stocks represent nearly 44% of the global market, so if you “diversify” entirely in the SP500, that is what you are leaving off the table. After seeing the above, Alex Bryan, a CFA and the director of passive strategies for North America from Morningstar, recommended the following last year:

“I think a small allocation of about a quarter to a third of your portfolio shouldn’t have a huge impact on the overall portfolio’s volatility because, even though that one piece of your portfolio might be a little bit more volatile, because international stocks aren’t perfectly correlated with U.S. stocks, the diversification benefits help offset that added volatility.” ⁽¹⁾

Although the SP500 HAS been quite profitable for the last 10 years, let’s jump into our time machine and take a look at the data from 2001-2010.

As you can tell, developed and especially emerging market stocks absolutely crushed the SP500 index with the former more than doubling your return, while emerging markets multiplied that same return 11.3 times over!

Furthermore, from 2000-2009, US stocks lost 33.75% while emerging markets gained 89.22%. ⁽²⁾

If 2001-2010 is simply “too long ago” for you to care, consider the following data from 2005 to 2018:

The SP500 in the meantime returned the following: 

2005 – 4.91%. 2006 – 15.79%. 2007 – 5.49%. 2008 – (-37%). 2009 – 26.46%.
2010 – 15.06%. 2011 – 2.11%. 2012 – 16%. 2013 – 32.39%. 2014 – 13.69%.
2015 – 1.38%. 2016 – 11.96%. 2017 – 19.42%. 2018 – (-4.38%).  ⁽³⁾

Even with the GREAT gains you see above, the SP500 was a loser every time compared to the top international markets of the same year. Naturally, picking the winner every time is a fool’s errand. If someone could do that consistently, they would likely be the richest person in the world!  However, this hopefully shows you that international investing is definitely not something to be ignored and by investing into international funds, you get a slice of that green, money pie. Let me say it again…

“The SP500 was a loser every time compared to the top international markets of the same year.“

Additionally, you can see that the periods between the US market outperforming international markets are very cyclical even going as far back as 1972: 

Fidelity (another investing powerhouse) recommends a range of 30-50% of exposure in international markets and finds that going back THIRTY years through 2019, the best stock markets have all been OUTSIDE of the US ⁽⁴⁾.  They have also mocked up a portfolio going as far back as 1950 through 2019 with their recommended 70 US/30 Intl portfolio, and you can see that the returns are the same as just the SP500 and suggests that international equity exposure may decrease portfolio risk over the long term:

1950 to 2019	US Portfolio	International Portfolio	Globally Balanced Portfolio 70% US/30% Int’l
Annualized returns	11.30%	10.30%	11.30%
Standard deviation	14.30%	15.10%	12.80%
Sharpe ratio	0.49	0.40	0.55

A recent Vanguard piece from June of this year ⁽⁵⁾ showed their own “in-house” simulation (from data current as of March 2020) that suggests the global non-US annual equity returns will beat out US-only equity returns by roughly 3% for the next 10 years.  Of course this is by no means a crystal ball, but Vanguard is yet another heavy hitter in the financial world that encourages international investing.  Coincidentally, their research further supports that having a 20-50% international market exposure reduces volatility as well:

The same article also references a few of the world’s largest companies that are NOT part of the US, but are likely well known to you regardless.  These are companies like Alibaba and Tencent from China, Nestle and HSBC from Europe, as well as Toyota, and a few other international companies that account for the top 50 largest stocks in the world.  Lastly, the article compares annual yields between the US and non-US equities which results in a difference of .65%, which should definitely be significant enough for anyone and everyone to consider an international portfolio.  As you can see in the graph above, Vanguard also recommends adding an allocation between 20-50% to international equities.

With that in mind, the TSP actually changed the I fund back in 2019 to mirror the MSCI EAFE (Europe Austral-Asia, and Far East) EX US – which includes both developed AND emerging markets (the “EX US” means US specific corporations are completely exempt from this fund). The TSP is now also including nearly 35% exposure in the L funds for 2055, 2060, AND 2065 options ⁽⁶⁾.  If you also look at the L2050, you can even see a bump in the I fund when they rebalanced these positions in 2019, roughly following the recommendations made above by Fidelity, Vanguard, AND Morningstar (as well as the majority of the big market heads).  

At the end of the day, it is your portfolio and your choice to make.  However, I believe that you should at least be well informed about the choices you make instead of listening to everyone that comes along that shows good returns (to include myself!).  Ultimately, the data does show that increasing your exposure to international (non-US) markets reduces your overall volatility due to diversification and can increase your returns to boot – which is definitely a good thing!

1) https://www.morningstar.com/articles/937958/should-you-bother-investing-abroad (if you are having issues viewing this, check the cached text version here: http://webcache.googleusercontent.com/search?q=cache:PJdFAAHdKDsJ:https://www.morningstar.com/articles/937958/should-you-bother-investing-abroad&hl=en&gl=us&strip=1&vwsrc=0) 

2) https://www.kiplinger.com/investing/etfs/601057/10-best-emerging-markets-etfs-for-a-global-rebound

3) https://www.slickcharts.com/sp500/returns 

4) https://www.fidelity.com/viewpoints/investing-ideas/international-investing-myths 

5) https://advisors.vanguard.com/insights/article/fourreasonstoembraceglobalinvesting6) https://www.tsp.gov/funds-lifecycle/

6) https://www.tsp.gov/funds-lifecycle/