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<\/a><\/p>\nIt\u2019s important to remember just how interconnected the global economy is today. If you walk into any big box retailer, most of the products you see on the shelves were manufactured somewhere other than the US. One can argue about whether that is a good or bad thing, but it means that the world\u2019s economy is tightly integrated. Global shipping routes give us a clear picture of that.<\/p>\n
The world economy is no longer divided into separate markets, where you can safely ignore what is happening on the other side of the globe. International stocks are actually a very good way to diversify. If we look at the historical data, US and international stocks have moved fairly independently from one another. The correlation (a statistical measure of how similar the movement of two series are) between the S&P 500 Index (a proxy for US stocks) and the MSCI EAFE Index (international developed stocks) from January 1970 to July 2016 was only 0.633.<\/p>\n To put that in perspective, over the same time period, the correlation between the S&P 500 Index and the CRSP 9-10 Index (which represents the very smallest companies in the US market) was 0.754. In other words, they are still stocks, but the US and International markets perform reasonably differently through time.<\/p>\n But it\u2019s important to note that just because they perform differently, there is no difference in expected returns.<\/p>\n Data from January 1970 to December 2018, courtesy of Dimensional Fund Advisors<\/em><\/p>\n Now, from the data above it may seem contradictory to state that there is no difference in expected returns between US and international stocks. But the key thing to notice here is the standard deviations for the two indices \u2013 they\u2019re relatively large numbers, which means that the returns tend to vary widely from year to year. In fact, they vary so much that here is no reliable statistical difference between the average annual returns.<\/p>\n What this means is that it\u2019s possible that the difference is purely random \u201cnoise\u201d. We have over forty-five years of data, and we can\u2019t reliably say that either the US or international stocks tend to outperform the other.<\/p>\n We can also see this if we simply look at how often international stocks outperform US stocks, and vice versa.<\/p>\n Monthly data from 1\/70-12\/18, annual data from 01\/70-12\/18, courtesy of Dimensional Fund Advisors<\/em><\/p>\n So, the two are pretty evenly split. If we were to select a random month, quarter, or year, it\u2019s just as likely that international stocks did better in that period than US stocks.<\/p>\n It\u2019s basically a coin flip whether US stocks will beat international stocks or international stocks will beat US stocks.<\/p>\n Let\u2019s think about coin flips for a moment. Everyone knows that you\u2019re equally likely to get heads or tails, and each flip is independent. If you got heads last time, that doesn\u2019t mean anything for the next flip \u2013 you still have a 50% chance of getting either heads or tails.<\/p>\n Let\u2019s say we filled all 63,000 seats of Cal\u2019s Memorial Stadium with investors flipping coins (wishful thinking for Cal fans, I know). Our goal is to find the best coin flipper. Everyone flips their coins at once, and if you flip heads you can stay for another flip, while flipping tails means you have to leave. It would take about 16 coin flips for us to expect to get a winner.<\/p>\n<\/a><\/p>\n
\nAlso, from a pure diversification stand point, we shouldn\u2019t exclude international stocks. We want to own as many securities as possible, in order to eliminate the risks that we\u2019re not compensated for as investors \u2013 company-specific, country-specific and industry-specific risks, for example.<\/p>\n<\/a><\/p>\n<\/a><\/p>\n