By the time most of us start thinking seriously about retirement, we are likely to be attracted to comfort and familiarity more than to adventure. However, retirees who keep their investments too close to home can wind up paying a high price for comfort.
For decades, I have preached the merits of investing in funds that own stocks of companies outside the U.S. I once described this as “putting the whole world to work for you” — and it’s a terrific idea. Let me show you why.
The equity portion of every portfolio I recommend is split evenly between U.S. stock funds and international stock funds. Some advisers think this is far too much emphasis on international investing, but over time the payoff has consistently shown up.
Less than half of the world’s total stock market value is represented by U.S.-based companies. Retired investors, in particular, should pay attention to this fact.
Why international diversification matters
International companies don’t always outperform domestic ones. That was certainly true in the 1990s, when a strong bull market in U.S. stocks convinced many investors that everything they needed was right here at home.
But the bear markets that followed in the early years of this century demonstrated the value of diversification. International stocks — including emerging markets — helped soften the blow and improve long-term results.
We have reliable data on international stock indexes going back to the 1950s, and it tells an important story.
In my book “Live It Up Without Outliving Your Money,” I described a 38-year study comparing two well-diversified all-equity portfolios. One invested solely in U.S. stock indexes. The other was split evenly between U.S. and international indexes.
Over that long period, the all-U.S. portfolio returned 12.1%. The portfolio split 50/50 between U.S. and international stocks returned 13.7%.
In any single year, that difference may not seem dramatic. Over several decades, however, it can mean the difference between retiring comfortably and barely scraping by.
Think this strategy is riskier? In nearly every measure we examined, the internationally diversified portfolio was actually less risky.
This is exactly the combination retirees need: higher returns with lower risk — and it’s easily achieved using index funds.
More recent evidence
It’s true that U.S. stocks have outperformed international stocks in recent years. But over the past 10 years, Morningstar data shows that diversification still paid off.
A two-fund portfolio of U.S. large-cap and small-cap stocks returned 8.8%. A four-fund portfolio — combining large and small companies from both the U.S. and international markets — returned 9.75%.
That occurred during a decade that was extremely unsettling for many investors.
Why this matters even more for retirees
If you are withdrawing money from your portfolio, international diversification becomes even more valuable.
As I explained in “Live It Up Without Outliving Your Money,” a portfolio that must support ongoing withdrawals has very different needs from one that is still accumulating assets.
For retirees, stability — avoiding large losses — is critical. Even a single disastrous year can permanently damage a retirement plan.
The biggest financial risk most retirees face is running out of money too soon.
In my book, I presented a 38-year study starting in 1970. Each hypothetical portfolio began with $1 million and was required to provide $60,000 in income the first year, with withdrawals increasing annually to keep pace with inflation.
Half of each portfolio was invested in fixed-income funds. The only difference among the portfolios was how the equity portion was allocated.
The first portfolio invested its equity entirely in U.S. stocks. By the end of 2007, it was worth just $500,226 and was effectively doomed, needing more than $214,000 for withdrawals in 2008.
The second portfolio allocated just 15% of the total portfolio to international stocks. That single change made a dramatic difference: by the end of 2007, the portfolio was worth about $4.2 million.
The third portfolio increased international exposure to 25%. By the end of 2007, it was worth more than $6.5 million.
The takeaway for retirees
The lesson is simple and clear. If you want to truly “live it up without outliving your money,” international stocks should be part of your retirement portfolio.
Richard Buck contributed to this article.