Why I Think International Diversification Is a Good Idea

A question that comes up, over and over in my email as well as on the Bogleheads forum is whether you really need international diversification, or whether sticking with only U.S. stocks is fine.

I’m a firm believer that it’s worthwhile to include an international stock fund in the portfolio.

The reason, however, has nothing to do with a rebalancing bonus, mean-variance optimization, or any particularly complicated math. As I’ve written elsewhere, I’m not optimistic about the possibility of creating a portfolio of assets with low correlation to each other, in such a way that they can reliably smooth out each other’s periods of poor performance. (And if you bother to look, international stocks and U.S. stocks actually have reliably high correlation with each other.)

For me, including international stocks in my portfolio is about diversification in a very fundamental, basic way: if I include international stocks, I have more stocks in my portfolio. This is diversification in the sense that your great, great grandparents would still have intuitively understood.

If any one stock has terrible performance, it has less of an impact on me. That’s a good thing. Because companies blow up sometimes.

And diversification is helpful from the other perspective as well: not just in terms of minimizing harm (from a company failing) but in terms of minimizing the likelihood of missed returns from failing to include a shooting star.

In the 20-30 years I’ve been learning about investing, the finding that stunned me the most was that most stocks actually have lower lifetime returns than 1-month Treasury bills. It’s a relatively small handful of very high-performing stocks that account for the entirety of stocks’ collective outperformance over safer assets. (When looking at the US stock market, if you eliminate the best-performing 4% of stocks, the remainder of the stock market has only matched Treasury bill performance.)

I don’t have any method for reliably picking those superstar stocks. (If I did, I would not be using mutual funds at all.) I want to own all the stocks, to be sure that I own those 4%. And that means owning international stocks also.