The tendency to invest disproportionately in your own country is known as home country bias and is a common inclination for investors all around the world. Note: this tendency is referred to as a bias for a reason – it can lead investors to make decisions that are in conflict with fundamentals. It is easy to understand how this bias occurs as it’s natural to be more familiar and comfortable with market conditions, political issues and public companies in your own home country.
It’s especially easy to fall prey to this bias as an American investor. After all, the U.S. economy is the largest in the world, and the S&P 500 Index is quoted and referred to so often in the media that it is seen by many U.S. investors as their default benchmark despite the fact that it represents less than half of the available investment universe worldwide. The inherent danger in this bias is that many investors that have a strong preference toward domestic investments often mistakenly believe that by doing so, they are taking less risk in their portfolio. Although it is counterintuitive, the opposite tends to be true due to reduced diversification, which can lead to higher volatility and lower returns.
Home country bias can have real opportunity costs as well. Markets have shown us that U.S. equities experience periods of underperformance that can last for years at a time, as we most recently experienced from 2002-2007 when international equities outperformed substantially. Investors that limit their opportunity set to domestic securities could be passing up the chance to invest in markets that are more attractively valued and have better growth prospects.
Current market conditions make this a critical issue for today’s investors. Domestic equities have turned in exceptionally strong returns and have outperformed international markets three out of the last four years. Many individual investors seem to have viewed this recent trend as confirmation of the soundness of their home country bias and have reacted by pouring even more money into domestic investments. In contrast, many professional investment managers including Legacy Trust believe that the substantial run-up in prices has led U.S. equities to appear broadly overvalued, and find more attractive fundamentals in international stocks. Emerging market equities in particular appear to be reasonably priced, and easing monetary policy combined with lower energy costs are creating an attractive environment for economic growth in many countries.
One of the key responsibilities of a professional wealth manager is to help clients recognize that behavioral biases exist, and it is important to be aware of them when considering investment options. Ultimately, the size and strength of the U.S. economy is such that an unbiased, fundamentally driven asset allocation analysis may well recommend investing the biggest portion of your assets at home – as long as you’re open to seizing opportunities when they exist overseas as well. Your portfolio will be better off in the long run.