Home bias is the tendency of investors to invest a majority of their assets in companies domiciled in their home country. Investors who fall prey to this bias often ignore the benefits of diversifying into foreign investments.
In recent years, a home bias has seen an advantage for United States citizens because U.S. stocks have outperformed the world market. However, the performance difference between U.S. Stocks and foreign stocks is cyclical with one winning for a long time before it tilts the other direction.
This 2019 article features the following chart which shows the performance difference between U.S. Stocks and foreign stocks over time:
Recency bias is the tendency for humans to believe that what has happened recently will continue to happen in the future. Recency bias makes us believe that because U.S. stocks have outperformed, they will continue to outperform in the future. Phrases like “U.S. stocks are outperforming” makes it seem like what happened in the past is continuing into the present. In reality, we do not know how U.S. stocks are fairing right now.
We don’t know which country will see the best returns today, tomorrow, or over the next few years.
In our 2014 article “Freedom Investing Since 2000,” I used returns from 2000 to 2014 to show how foreign stocks can outperform U.S. stocks for over a decade. Today, I could write a similar article demonstrating the opposite.
The idea of hedging your bets by investing some of your money in foreign stocks and some of your money in U.S. stocks is not new.
Diversification is a staple of financial advice. Don’t put all your eggs in one basket because if you drop the basket you won’t have any eggs.
In month-to-month snapshots, diversification dampens both the highs and the lows. You always have an investment to complain about and an investment that is your darling. If you cut the investment you are upset with out of your portfolio, then you will no longer have its diversification benefits and may be jeopardizing your retirement when your darling goes down.
The goal isn’t to invest only in what goes up. The goal is to support your financial needs, which is why your portfolio needs diversification.
You don’t get a second chance at retirement.
Diversification is responsible. It is the difference between being willing to break every bone in your body as an Olympic skier and safely skiing with friends. You should strive to have as consistent a return as possible. To accomplish that, we recommend that you diversify your portfolio between U.S. and Foreign investments.
Home bias is not unique to U.S. citizens. This article shares what percentage of all the investments of native investors are invested in their home country. The percentages are 65% for Canada, 50% for United Kingdom, 74% for Australia, and 72% for the United States.
Here in America, home bias means investing in only the United States. Although indiscriminate foreign investing may under perform the United States, diversification among the other free countries provides a more consistent return than investing only in the United States.
Photo of Australia by City of Gold Coast on Unsplash