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Should you own foreign stocks?

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You wouldn't put your retirement savings exclusively in the company you work for (I hope), or in companies based in the city or state where you live. The name of the game, after all, is diversification.

Unless you're a genius, blessed with dumb luck, or illegally profiting from insider information, you are going to find it very difficult to outsmart full-time professional speculators and beat the market. That's why everyone recommends owning a broad portfolio of assets so you can benefit from general economic trends rather than putting all your eggs in one basket.

But if you shouldn't limit yourself to your hometown, then why stick to your home country? It's commonplace in the modern United States to own Japanese cars and Korean televisions while drinking Argentine wine and cooking with Italian olive oil, so why limit yourself to American stocks?

Most experts believe you should invest at least some of your retirement savings in international stocks. But there's surprisingly little consensus about how much.

Home country bias is a big problem in small countries

Home country bias in investing is almost certainly a big mistake for residents of small countries. Back in its heyday 15 years ago, for example, "Nokia single-handedly accounted for more than 70% of the market capitalization" of the Helsinki Stock Exchange.

Under the circumstances, for a Finnish investor to be investing exclusively in Finnish stocks would have practically amounted to investing exclusively in Nokia.

That's a bad, undiversified portfolio on its own terms. But it's especially bad because Nokia was so dominant in the Finnish economy that everyone was already exposed to enormous amounts of implicit Nokia risk. The company's near-total collapse over the past five years has had a sharply deleterious effect on the entire Finnish economy, pushing unemployment up and forcing the government into rounds of austerity budgeting.

Finland is, of course, an extreme case, in terms of both being a very small country and hosting a large multinational company in the recent past. But extremes are useful for illustrating the general point. The idea that holding a broad stock market index constitutes a useful diversification strategy depends on the idea that the stock market index is, in fact, broad. The smaller the country, the less broad the index and the more you are exposed to idiosyncratic risk factors associated with particular companies or industries.

The case for investing domestically

The United States hosts the world's largest stock market, so it's not like you absolutely need to look to foreign shores to hold a diverse portfolio.

Still, the United States contains only about 4.4 percent of the world's people, 16 percent of the world's GDP, and about 50 percent of the world's stock market value. Thus, on strict diversification grounds an unbiased portfolio would be about half American and half foreign. In practice, almost all experts advise some home country bias in one's portfolio.

One reason has to do with exchange rates. If your home country's economy happens to boom as you near retirement — driving both asset prices and the cost of living upward — you want the value of your investments to rise with it. If half of your money were invested overseas, your portfolio might not keep up with the cost of living.

Another important principle of investing is to keep costs as low as possible, and investing in international assets is inherently costlier than investing in domestic ones. To be sure, modern mutual funds have made great strides in cutting costs. Vanguard, for example, offers an international index fund that costs just 0.12 percent of your portfolio value per year — well below the industry average even for domestic stocks. Still, Vanguard's equivalent fund for domestic stock investments costs 0.05 percent of your portfolio's value. That's less than half as expensive.

Experts don't agree on how much foreign stock to hold

So it's clear that you should have some bias toward domestic stocks. But there is shockingly little consensus on how much. When the Wall Street Journal surveyed 10 experts how much foreign stock an American saver should own in 2013, answers ranged from 10 percent to 40 percent of the total portfolio. Terrance Odean, a finance specialist at the University of California Berkeley's Haas School of Business, offered his expert opinion that experts have no idea.

"Recently I've been asking financial experts this same question," he wrote. "I get a lot of answers. Everyone agrees that the percentage is more than 0 and less than 100."

In fact, it's even worse than Odean says. John Bogle, the legendary founder of Vanguard, says he thinks Americans should eschew foreign stock altogether. His successors disagree, however. Their latest research into the question suggests the appropriate figure is between 20 and 40 percent, depending on your risk tolerance.

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