Home Country Bias

TL;DR

A little home country bias in portfolio diversification may not be a bad thing, as global diversification carries higher costs and taxes for Canadian investors.

Transcript

• Global diversification is one of the keys to a well-constructed portfolio. We've known this for a long time, and investors have been largely ignoring it for just as long. In a 1991 paper titled Investor Diversification and International Equity Markets, Ken French and James Poterba documented the concept of investors preference for owning stocks i... Read More

Key Insights

• 👪 Home country bias is still prevalent among investors, despite the well-documented benefits of global diversification.
• 👪 Global diversification provides access to economies outside of one's home country and reduces the risk of poor economic performance in a single country.
• 🌍 Adding international equities to a domestic portfolio can decrease volatility and increase expected returns.
• 🚱 The optimal allocation for Canadian investors may be around 50% to 60% in non-Canadian stocks to achieve maximum volatility reduction.
• 🧑‍💼 The cost and tax considerations of investing outside of Canada make it important to weigh the trade-offs of global diversification.
• 🚕 Canadian stocks are more tax-efficient than non-Canadian stocks, which could impact the allocation decision.
• 👪 Behavioral tendencies and the urge to increase allocation to the home country when it performs well pose a risk to optimal diversification.

Questions & Answers

Q: What is home country bias in portfolio diversification and why do investors tend to exhibit it?

Home country bias refers to investors' preference for owning stocks in their home country. This bias is driven by the expectation of higher returns in domestic markets compared to other markets. It is a common phenomenon due to familiarity and the perception of reduced risk.

Q: Why is global diversification important in a portfolio?

Global diversification allows investors to access economies outside of their home country, reducing the risk of poor long-term economic performance in a single country. It also provides exposure to a larger subset of global stocks, as most global stock market returns come from a small percentage of stocks.

Q: What are the benefits of adding international equities to a domestic portfolio?

Adding international equities to a domestic portfolio tends to decrease portfolio volatility while increasing expected returns. This diversification can help manage risk and potentially enhance long-term portfolio performance.

Q: How does asset allocation impact portfolio volatility?

Vanguard's research suggests that the maximum expected volatility reduction is achieved when a Canadian investor allocates somewhere between 50% and 60% of their equity portfolio to non-Canadian stocks. Allocating more than that may increase volatility.

Summary & Key Takeaways

• Global diversification in a portfolio is important for accessing economies outside of one's home country and avoiding the risk of poor long-term economic performance in a single country.

• Adding international equities to a domestic portfolio can decrease risk and increase expected returns.

• Vanguard's research suggests that an optimal allocation for Canadian investors is somewhere between 50% and 60% in non-Canadian stocks to achieve maximum volatility reduction.