(PUB) Investing 2016

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Fund Family Shareholder Association

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relate to developing countries strug-

gling to find their place in a global

economy, not the longstanding, devel-

oped European economies of Greece,

Portugal or Spain. The Brexit vote is

only the latest demonstration that there

is plenty of political risk to be found

in Europe, along with croissants and

espressos.

Proponents of a U.S.-only stock

approach, like Jack Bogle, would argue

that you don’t need to introduce these

risks to your portfolio by investing

overseas. However, the flip side of that

coin is that if you don’t diversify your

investments, all of your currency and

political risk is tied up in a single coun-

try—the U.S.

I mentioned at the start that the

Brexit vote was an example of why one

should diversify their portfolio beyond

their home borders. Well, imagine for

a moment that you were a U.K. inves-

tor who only owned U.K. stocks. You

just got a double dose of political and

currency risk. Not only did your stock

portfolio decline 5.6% in two days, but

your purchasing power fell 10% or so.

Had you diversified beyond the U.K.,

your foreign holdings would’ve at least

benefited from the fall in the pound.

So given the need to weigh all these

potential risks and rewards, how should

you and I incorporate foreign stocks

into our portfolios?

As discussed above, I don’t agree

with either the no-foreign-fund camp or

the indexing apostles who suggest that

having roughly 50% of our portfolio in

foreign stocks is the scientifically proven

route to take. You have to look beyond

the raw data to find the best strategy for

you. I think the

Model Portfolios

are the

best place to find an allocation that suits

your needs. Only investors with con-

servative goals combining growth and

income should consider a commitment

of 10% or less to foreign equities.

Cyclical Noise

Regardless of what you decide is

the right level of foreign exposure for

your portfolio; allow me to offer a

word of caution. The difference in

performance between U.S. and foreign

stocks has been cyclical, and this means

that sometimes owning foreign stocks

will look very smart, and other times

it will look less so. Unfortunately, I’ve

noticed that the arguments for and

against investing in foreign funds tend

to follow performance. Don’t let your

allocation follow the swinging pendu-

lum—have a plan and stick to it.

Take a look at the left chart above,

which shows the relative performance

of Total Stock Market Index and Total

International Stock Index since the for-

eign index fund’s inception, and you’ll

see why most investors have remained

shy of the foreign markets. When the

line is rising, U.S. stocks are outper-

forming foreign stocks (all based on

U.S. dollar returns, of course). When

the line is falling, foreign stocks are

leading. As the chart shows, there was a

long stretch from the mid-’90s to early

2002 when U.S. stocks led, followed

by a long period of foreign stock domi-

nance until the middle of 2008. Since

then, U.S. stocks have outperformed.

Not too surprisingly, those arguing

against the need for foreign funds were

loudest in the late ’90s. Those arguing

for increased allocations to interna-

tional stocks dominated the dialogue

beginning in the early years of this past

decade, then lost the megaphone again

after the Great Recession as U.S. stocks

powered ahead once more. Social psy-

chologists refer to this tendency to

extrapolate our most recent experience

into the future as “recency bias.” And it

exerts a powerful pull on investors.

Finally, some will argue there are

times to be heavily invested overseas,

and times when you should keep your

money at home. Thanks. That’s like

saying you should invest heavily in

stocks when they’re going up, but not

when they’re going down. Market tim-

ing is tough already, and trying to decide

Domestic vs. Foreign Stock

Leadership

5/96

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5/02

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5/06

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5/10

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5/16

0.80

1.00

1.20

1.40

1.60

1.80

2.00

2.20

Rising line = U.S. market outperforms foreign markets

Total Stock vs. Total International Stock Index

MSCI EAFE Over 40 Years

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5/76

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5/92

5/96

5/00

5/04

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5/16

U.K. and Europe Not Always on the Same Page

1957:

Treaty of Rome is signed by France, West Germany, Italy, Belgium, Luxembourg and the

Netherlands, creating the European Economic Community (EEC), the precursor to the European

Union. The U.K. withdraws from early talks.

1963:

France vetoes the U.K. joining EEC.

1973:

The U.K. joins the EEC.

1979:

The European Exchange Rate Mechanism (ERM), which was set up to ready European

countries for the creation of the euro currency, is established. The U.K. abstains.

1990:

The U.K. joins the ERM.

1992:

The U.K. is forced to withdraw from the ERM.

1997:

The U.K. decides not to adopt the euro.

2011:

David Cameron promises an In/Out referendum on E.U. membership if he wins the 2015

general election.

2016:

Cameron wins and a date for the referendum, June 23, is announced in February.

June 23, 2016:

The U.K. votes to exit the E.U.