This post is a response to the 20 Something Finance blog post "Is the U.S. Vs. International Stock Allocation 80/20 Rule a Conspiracy?" and the comments on the blog post.
A very well done, thought-provoking analysis. I actually have about 40% invested in foreign markets (I use what's essentially an Aronson lazy portfolio). I think that there's a really good reason for most people to keep the vast majority of their investments in U.S. companies, though. (And, in fact, for anyone in any country to invest primarily in their own country.) Why? Because unless you're willing to move abroad, your primary concern is growing wealth *in your own currency*, and at least parallel to your peers. Remember, diversification is about managing and spreading risk, and only secondarily about taking advantage of opportunities.
Another one of the commenters compared the 80/20 domestic/foreign advice with the advice that people should never invest more than 10% in their own employer (and really, not more than 5% in any one investment). If you both work for a company and invest in it, you're increasing your dependence on that single company and the risk that that company will severely impair your finances *relative to your peers*. 99+% of the country will not be working at that same company, so your finances will have gone down the tube, but the rest of the country will barely have noticed. Your relative wealth has spiraled, as has your buying power and ability to provide for yourself and your family — compared to everyone else around you. Additionally, you're now working somewhere else.
So there are two factors:
1. Finances compared to peers
2. Ability to leave "bankrupt company" (country in our case)
Neither of these factors are true in domestic vs foreign investing. As a matter of fact, the opposite is true for most people. Let's consider the two extreme cases to understand why this is dangerous. I know that neither one of these cases are terribly likely (world economies are too tightly knit), but you have to understand where you're assigning risk.
* Case 1: The finances of the U.S. fall apart relative to the rest of the world
** Let's assume that you do invest 80-90% in foreign investments (the opposite of the traditional advice).
In this case, you're rich! You're on top of the world and your finances are vastly improved compared to your peers (your countrymen). Most of the rest of the country is poor! Great! You can stay in the U.S., live well, and hopefully you'll help out some of your peers (voluntarily, of course — what's with government believing that spreading wealth under the threat of criminal prosecution is going to improve society?).
** Let's assume that you keep the traditional 80/20 domestic/foreign allocation.
Yeah, you missed out on becoming rich compared to the rest of your peers (the country), but it's not nearly as big of a deal as your employer going under. Your buying power has remained the same relative to your peers. Now, would you leave the U.S. to seek better economic opportunities? Leave your extended family? Possibly learn another language if all the English-speaking countries hit the fan? Most Americans want to die Americans. That could change, but things would have to get pretty dire. You'd probably just stick it out here knowing that you have it no worse than anyone else you know.
* Case 2: The finances of the rest of the world fall apart, but the U.S. stays strong
** Let's assume that you do invest 80-90% in foreign investments (the opposite of the traditional advice).
In this case, you're screwed. Relative to all of your peers (the rest of the country), you're broke. Well, in this debt- and consumer-oriented country most everyone is broke, so that just aligns you with your peers. However, in your own mind, you know that you went from believing that you had very carefully managed your finances, to having much, much less. At least there's a strong government to provide your Social Security.
** Let's assume that you keep the traditional 80/20 domestic/foreign allocation.
In this case, your finances haven't changed much relative to your peers. Life goes on in the U.S.. You're really glad that you don't live abroad.
So, the risk is really that you could be left with nothing relative to your peers. That only happens if you buck the traditional allocation advice. I'm a Libertarian, I have nothing against bucking the status quo, but in this case, I would recommend against it. The vast majority of people retire in their own countries, which means that they need their investments to maintain value in their own countries. What happens in other countries may present a lot of opportunity — or it may present a lot of risk — but you're not retiring in those countries so you want to make what happens in them is secondary as far as your investments go.
