VT vs VTI

[Ad Orientem]

I know Harry Browne advocated using a broad based index fund to capture the profits of equities during times of economic prosperity.  But how firm was he in limiting equities exposure to US markets?  I don't really recall him taking a dogmatic stand on the point.  If your dollar (deflation) hedge is primarily LTTs with STTs as a back up is there a compelling argument for restricting your stock market exposure to USD denominated securities?  Conversely if the 25% allocation of the PP to equities is intended to capture the profits of a period of general economic prosperity, does it make sense to limit oneself to 40% of the market in an increasingly globalized economy?

Thoughts? Pros Cons?

[Tortoise]

... if the 25% allocation of the PP to equities is intended to capture the profits of a period of general economic prosperity, does it make sense to limit oneself to 40% of the market in an increasingly globalized economy?

Doesn't an increasingly globalized economy mean international diversification of stocks is less, not more, important? Increased globalization means business conditions in different countries are more correlated today than they were in previous decades.

If my domestic stock portfolio only represents 40% of the global market, but that 40% is very highly correlated with the other 60%, I don't necessarily see a problem with being invested in "only" 40% of the market. It's the cheapest 40% for me to own since international funds typically have higher expense ratios than domestic funds do--and every dollar I save in expenses is a dollar of guaranteed return.

As I understand it, the biggest difference in performance between domestic and international stock funds nowadays is due to currency movements. And in a PermPort, the idea is that the 25% gold allocation provides all the protection one needs against domestic currency weakness.

[Kshartle]

I think restricting oneself to just domestic equities is riskier than a global allocation. Yes they are highly correlated but correlations can break down. You're putting yourself to the risk of a calamity that befals the US disprapotionatly. I am 100% that the global economy will continue to grow but I'm slightly less confident in the US economy. Debt, empire, entitlment society, all our problems make me more bearish on the future of the US compared to many other regions of the globe (despite their problems).

I think the argument that's usually put forward here is that the US is so big and our large caps are really global anyway so you don't need to diversify further. I happen to disagree. I just think the purchasing power and production of the US is going to continue it's decline relative to the rest of the world. I don't know exactly which countries or people will do best but I prefer to own them all. I could absolutley be wrong but I think we've got a near free lunch here with easy diversification that can be had for a couple basis points.

[melveyr]

I think the interactions between the US bond market and the US stock market are a cornerstone of the PP. The PP is all about capturing the closed possibilities within the economy, so I think adding assets that are less relevant to the US economy is an undesired deviation. If the US economy does poorly, I think either Treasuries or gold will respond appropriately. Adding international stocks just muddies up the clarity IMO.

[Kshartle]

Your point is well taken. However I kind of think that US treasuries are a global asset class of sorts in that international investors make seek their preceived safety when they feel the fear of their own equity markets.

As far as the possibilities inside the US econonmy, doesn't it make more sense to invest with a global mindset? The US economy might out perform the rest of the globe or vice versa but isn't there significantly less risk in taking a global approach? I guess I can envision scenario where the US expreiences stagflation or tepid growth for decades (like Japan for example) or a major crash that takes decades to recover from. The idea that the globe is just as likely to have this happen seems remote to me. I have more confidence in the equity, debt-instruments and cash of the entire earth than just the USA.

The PP precepts are sound because of the wide diversification between the asset classes. I think that a global portfolio of the assets is just safer in the long run. I think this is probably a topic that many of us seriously disagree on and we've probably beat it to death without convincing each other though.

[KevinW]

The topic of using a world stock fund, or more generally investing in international stocks, has been discussed may times, e.g.

http://gyroscopicinvesting.com/forum/ht ... ic.php?t=6

http://gyroscopicinvesting.com/forum/ht ... ic.php?t=3

As I said in the older thread,

Here are the reasons why I only use the domestic total stock market:

The premise of the PP is that "the economy" can be in one of four conditions, and there is an asset tied to each condition.  For the PP to work as designed, "the economy" needs to mean the same thing in each case.  If cash is US T-bills prepared for US recession, and bonds are US T-bonds prepared for US deflation, then stocks need to be US stocks prepared for US prosperity.

Total stock funds are dominated by large multinational companies that operate in overseas markets.  So a TSM fund already has a built-in mechanism for profiting from whatever's going on in international economies.  I think management at these companies is in a better position to decide where to invest working capital than I am.

There are cogent arguments for adding international stocks to a traditional stock/bond portfolio.  Such a portfolio has no currency hedge, and mixing in stocks denominated in foreign currencies has a strong diversification effect.  However the PP already has a strong currency hedge from the 25% gold allocation.  Adding a currency hedge to a non-hedged portfolio has a big effect; adding a second hedge has a much smaller effect.  IMO many of the arguments and studies about international diversification are not relevant to the PP.

International funds have higher expenses than domestic ones, and adding a fifth asset class increases transaction costs.

Since the PP holds a relatively small amount of stock, the international stock allocation may end up being an insignificantly small piece of the overall portfolio anyway.  20% (say) of 25% is 5%, and it's questionable whether tilting 5% of the portfolio has any meaningful effect.

Straying from the 4x25 allocation can be a slippery slope.  There's risk that tinkering with one asset class will lead to tinkering with others, to the detriment of the portfolio.

I'll be saving this for future copy-pasting since this question seems to get asked at least once a week .  Or maybe we could sticky this thread?

That said, _IF_ someone is committed to holding both US and ex-US stocks, I think a total world index such as VT is better than two different funds. A single fund will have less transaction costs, taxes, and temptation for market timing.

[KevinW]

The PP precepts are sound because of the wide diversification between the asset classes. I think that a global portfolio of the assets is just safer in the long run. I think this is probably a topic that many of us seriously disagree on and we've probably beat it to death without convincing each other though.

I agree that a globalized PP with global stock, global bonds, and global cash would work the same as any other PP. I would concede that the globalized portfolio is ever so slightly safer than a single-country (e.g. US) PP. However the expenses are worse and hassle is much greater, and I don't believe the slight diversification benefit is worth it. If global sovereign bond index funds with reasonable expense ratios come into being, I might change my mind.

[Gosso]

As I understand it, the biggest difference in performance between domestic and international stock funds nowadays is due to currency movements. And in a PermPort, the idea is that the 25% gold allocation provides all the protection one needs against domestic currency weakness.

Bingo!  An American investor benefited greatly over the past decade from international equity due to the weakening USD.  But a Canadian investor was hurt by international equity since the CAD increased in value.  The US and Canadian investor could have held roughly the same international assets, yet saw completely different returns over the past decade due to their local currency.

Too much exposure to international assets will likely cause greater volatility in the PermPort, and will result in periods of long under-performance when the local currency increases in value.

For non-US investors, I think there is room to increase international assets, but I would keep at least 50% in the local currency.

[melveyr]

Does anyone know how a US investor would go about buying UK gilts or Japanese Notes?

What are the institutional and tax hoops one must jump through?

[craigr]

When you buy international bonds you are buying potential exposure to that country's inflation. I'm sure that those country's governments appreciate your business, but your portfolio will be very unhappy. Fair warning.

Stocks are not as bad though. But remember that US companies make a tremendous amount of money from overseas. So don't think you have no overseas exposure just because you hold US companies, because you do!