Non-US Investment Principles Different From Common Investment Advice

Today’s post is from Mr Credit Card of www.askmrcreditcard.com. Today, he is going to veer off his usual credit card topic and discuss how non-US investors approach investments differently. If you are a US reader and happen to be looking for a credit card, his best credit cards section and business credit cards page might be worth checking out.

For the last few decades, the practice and theories in finance has been driven by academics and the financial industry from the US. The CAPM Model and using beta as a measure of risk, options pricing theory, the efficient market hypothesis and asset allocation all have had great influences over modern financial practices. Furthermore, studies done is the US using stock price data from 1926 till modern day shows that US stocks have historically risen in the long run and that “stocks are the best investments for the long run”.

But the flaw with these arguments is that the research and studies have taken place in the world’s dominant economy during the last century. But the majority of the world’s population does not live in the US. Does most of the current literature on finance apply to those who live outside the US? What if you are from Canada, Japan, Latin America, Russia or China?

Here is how common wisdom in personal finance may be flawed for those who live outside the US.

Stocks for the long run – This study was done using data from 1929 (after the market crash – how convenient) till present day. At the same time studies were done on the performance of bonds and the conclusion was made that stocks outperformed bonds “in the long run” – although studies have always failed to mention that long bond rates in the US was capped in the 50s!

The problem with this study is that perhaps it applies to the US investor and if the United States is still an economic superpower for another century then perhaps it would be wise to take this advice. But if this study was conducted elsewhere, the results will not be universal. For example, Russia became a communist country in the early twentieth century, and so did China. The German Mark changed its composition a few times. Many Latin American Countries have defaulted numerous times. Investors outside the US would be foolish to simply take this study as a guide. Stocks may be good in the long run in countries with stable political systems.

Asset Allocation for international investors – The common advice dished out to individual investors is to split your allocation between stocks and bonds and throw in some (maybe 5% to 10%) exposure to international stocks. This may have worked for US investors but the advice could simply be impractical for non-US investors. What if an individual came from a country with no developed stock markets (or bond markets for that matter)? What is that investor going to do?

Too much country risk – A non-US investor can take the conventional US-centric advice and invest in his home market’s stock market, on the believe that the stock market “always” goes up in the long run. For a non-US investor, this presents a problem as most other countries do not have the political stability of the United States. In fact, the US, Canada, and Australia were some of the few countries that was never invaded in the twentieth century.

Let’s use Japan as an example. The Nikkei 225 index has stagnated for over a decade. The Japanese Government has debt up to their eyeballs. What is a Japanese investor to do. If he or she were only to invest in the domestic market, they might have too much concentrated country risk. Imagine what the citizens of the Asian countries who had the Asian Crisis in the late 90s must have felt when they currencies collapsed.

Investment fees too high – While the investment product market is relatively competitive in the US, it is not the case in some non-US markets. Loaded mutual funds are still common elsewhere. Because of it’s economic size and scale, large mutual funds can afford to waive loads on their funds. Many smaller non-US investment firms do not have this luxury.

How should a non-US investor invest?

So given that the research done in the US may not be applicable to most countries, how should a non-US investor invest? I think the best way to look at it is to see how the relatively wealthy have invested.

Have investment in countries with hard currencies – At any point in history, there have only been a couple of currencies that was deemed the “international currency”, the currency of choice for international commerce. In modern times, that currency is the US Dollar, the Euro and to a certain extent, the Japanese Yen.

An investor from a country whose currency is not an international currency should consider having some form of savings in an international currency. In Asia, most of the wealthy folks from Indonesia, Philippines etc have lots of US Dollar, same with the folks from Latin America.

International Asset Allocation – Non-US investors should ideally practice proper international asset allocation (perhaps based on market capitalization). That inevitably means investments in the developed and emerging markets – it will involve exposure to the US stock market, European stock market and other international markets as well. It also means having exposure to international bonds. Such investors will probably have very little allocation to stocks in their home country.

Invest in real estate – Having overseas real estate investments is something many wealthy folks from countries with political instability have as a hedge against, well, political instability. Many Indonesians and even Chinese have real estate investments in Singapore and the US. Russian oligarchs have real estate investments in London. Many of them have paid high prices for them, but consider them insurance money!

Have bank accounts abroad – Many citizens of politically unstable countries also have bank accounts abroad just in case.

Ending Thoughts – Those of us in the US and Canada have enjoyed decades of peace and prosperity. Financial theory has grown primarily from the US because for the last century, it has been the largest financial markets and much data and studies have been done. These studies have resulted in popular thesis like “the stock market always goes up in the long run”. These results may not hold true for most other investors from other countries who are from smaller countries or from politically unstable countries.

While some of the illustrations above could be considered a little overboard because perhaps only wealthy folks do them, it just goes to show that investing for the rest of the world outside North America is very different.

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