Why invest in global markets is a question many investors face. The theory goes, that if you are investing in a large market like the US or UK (but less so) you don’t need to the exposure global markets provide.
You’ll commonly hear two arguments for this:
Why you don’t need to invest in global markets
- Large US and UK indices like the S&P500 and the FTSE100 generate a large proportion of their revenues from international markets. This gives you plenty of international exposure without having to take on the risk associated with overseas global markets.
- Limiting your exposure to your home market keeps things cheap, and fees are arguably the most important factor in any investment.
In the US 40 to 50% of S&P500 sales are from abroad, and in the UK 76% of sales are from abroad. On the face of it the question of why invest in global markets looks a little more difficult to answer.
Investing through an S&P500 or FTSE100 fund is certainly a cost effective way to invest. Both these funds are available with total expense ratios (TER) of 0.07%, where as the iShares MSCI World fund has a TER of 0.50%. That’s a big difference over the long term.
These arguments both have merit. So much so that investing giants like John Bogle of Vanguard and Warren Buffet both advocate for Americans to stick to their home market.
Diversification
However, almost as important as fees themselves is diversification. Avoiding placing all your eggs in one basket by spreading your investments throughout global markets is a strong argument for adding international exposure to your portfolio.
Although, the S&P and FTSE do have international revenues, it doesn’t stop them from going up and down at different times to other global markets. Sometimes they’ll move in the same direction but sometimes they won’t.
The FTSE100 contains a list of 100 UK companies. The fact that they do business overseas doesn’t change that. The S&P500 is a list of US companies.
All the worlds major economies have indices of their own with their own companies on them. When you invest in an international market or index you are investing in another set of companies.
The more companies you invest in, the more diversified you will be. The more diversified you are, the less you are exposed to risk. No matter, whether a country’s company’s do business abroad or not, history tells us that individual stock markets can crash.
If we want to have a look at how stocks have performed historically a great place to start is the The Dow Jones Industrial Average (the Dow), a stock market index that represents 30 large publicly owned companies in the US.
Individual markets crash
During the crash of 1929 and subsequent Great Depression it lost almost 90% of its value and took 25 years to recover. Both the UK and US markets have crashed many times and always recovered.
However, that doesn’t guarantee that they will do in the future. We only have to look at some other stock markets around the world to see what might happen.
At the time of writing (May 2018) the Shanghai and Shenzhen stock markets are down about 40% from what they were prior to crashing about 10 years ago and the Japanese stock market is about 40% down from what it was before it crashed about 30 years ago.
Crashes do happen and they can take a long time to recover. Historically, the Dow Jones has crashed by over 40% eight times. Imagine if you were Japanese and your pension was down 60% from what you started with 30 years previously!
Being diversified across global markets could have prevented such heavy losses. I don’t think Japanese investors will be asking why they should invest in global markets.
Why go global?
At the end of the day, it’s a case of how much you value diversification.
Is it worth paying higher fees to be diversified?
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