For many people, there’s no place like home. It’s familiar and comfortable. But for your portfolio, staying at home means taking on a lot more risk than you might realise.
It’s natural to want to invest at home. If you live in Singapore, for example, you see the Singapore’s Straits Times Index (STI) quoted every night on the news. You drive by the DBS building every day. Jets bearing the Singapore Airlines logo fly above you, and you shop at a CapitaLand mall. Investing locally means investing in what you know – which, as we’ve written before, is generally smart.
Everyone is guilty of home country bias
So it’s not surprising that most people invest mostly in their home market. Due to “home country bias,” the average American with a stock portfolio has 79 percent of her money in U.S.-listed stocks. Investors in Japan put about 55 percent of their money in Japan-listed stocks. People in Australia have two-thirds of their portfolio in local shares.
That might be what they’re comfortable with. But from a portfolio diversification perspective, it’s like juggling live dynamite.
As the graph below shows, American stocks account for only 51 percent of total global market capitalisation (that is, the value of all stock markets in the world). So American investors are a lot more exposed to U.S.-listed companies than – based on a breakdown of the world’s markets – they should be. Japanese investors are even more lopsided in their home preference – Japan accounts for only 7 percent of the world’s stock market. And Australians put 66 percent of their money into their own market – which is just two percent of the world’s markets.
And Singapore’s stock market is only 0.4 percent of the world total, but Singaporeans invest about 39 percent in domestic equities. Home country bias means most investors have too much exposure to their local market.
Why do investors do this? Besides investing in what they know, studies have shown that domestic investors tend to be more optimistic about the local economy than are foreign investors. Also, local investors face fewer tax hassles when buying domestic shares, and less foreign currency risk. Investors often trust companies and stocks outside their borders less than they do those in their own country (even if the “foreign” market is bigger and less volatile than the local market).
How geographic diversification helps
A portfolio that isn’t sufficiently diversified is riskier than one that is well diversified. And geographical diversification is important, as we showed here. Since different markets outperform at different times, even though they all tend to move in the same general direction, having money invested in a range of geographical markets can boost your returns.
Make sure to assess the home bias of your own portfolio. If you have a severe case of home country bias, it would be wise to consider making a few adjustments to move some of your money elsewhere. Your portfolio can only benefit from being a little more cosmopolitan.
An easy, inexpensive way to diversify globally is to use ETFs. There are a variety of ETFs available on the Singapore and Hong Kong Exchanges that give you exposure to specific countries, or the entire global market. For example, in Singapore you can buy the Lyxxor UCITS MSCI World Index ETF (code: H1P). This gives you exposure to 23 different countries and most of the world’s biggest publicly-traded companies with one investment.