Whatever your views on the EU referendum, last week was a reminder of the value of international diversification. Despite the scary headlines, a UK based investor with a sensibly diversified portfolio would have ended the week richer (measured in £) than they started.
Below is an updated post that I originally published last year. It’s as relevant today as when first published. After the vote, maybe even more so. And if you replace “World Cup” with “European Cup” you could almost call it topical…
The Escape Artist is a patriot. But also a realist. I may root for England in the World Cup and the UK in the Eurovision song contest but I also know that we are not going to win every time.
So it is with investing. It would be convenient for us Brits if all the best companies in the world were headquartered and listed on our little set of damp rocks in the North Atlantic, but that is not the case.
The good news for UK based investors and FI seekers is that this doesn’t matter because investing internationally is easy.
I have often seen bad advice in the UK re the Safe Withdrawal Rate (SWR) that goes something like this:
Well, the SWR in the USA may be 4%. But that’s because America is the only economic superpower with the deepest capital markets, the most advanced tech companies and the biggest hot dogs etc etc. But in the UK we don’t make anything anymore and are generally a bit rubbish compared to our rich American cousins, so a UK investor should expect lower returns. So let’s assume the SWR in the UK is 3%.
This is Wrong (capital W). Its also potentially harmful: anyone following this advice is unnecessarily prolonging their stay in the Prison Camp. Here’s why:
1. You are allowed to buy international shares directly
Everyone can own a slice of the global economy. You don’t have to be an evil capitalist or wear a top hat and monocle. Contrary to what many of us were brought up to believe, the machine of global capitalism does not have to be oiled with the blood of the workers.
Investing overseas allows you to own shares in the most profitable and resilient companies on the face of the planet. Yes, there are some great companies listed in the UK. But by investing internationally we significantly enlarge the universe of great companies that we can invest in. This creates the potential to find better bargains elsewhere.
There is no law saying that us Brits can not buy American or continental European listed shares direct. Its really, really easy. You do not need to run a hedge fund, be an investment banker or even open an overseas broking account.
If you have an account with an decent low-cost online broker in the UK then you buy a US share in exactly the same way you would buy a UK listed share. There is no stamp duty and, with The Share Centre, there are no foreign exchange commissions. Watch out for the other brokers that levy an FX commission (most of them). This is a sneaky hidden charge: be warned as as the (hidden) FX cost can be much bigger than the (visible) dealing commission.
Whilst its important to minimise taxes and fees, I am not put off by the withholding tax on US dividends (15% once you’ve completed a W8-BEN form) for three reasons.
- If I want to own the lowest risk, highest quality growth companies in the world, I have to accept that many of them are listed in the US.
- Most of the US companies in my portfolio return more cash to shareholders via share buybacks than they do via dividends.
- My aim is to buy undervalued shares and hold them until they are over-valued and then sell. My average holding period is about 3 years currently.
As a result of these factors, the majority of my overall return has come from capital gains rather than dividends. So the withholding tax on dividends has a relatively small impact on overall returns.
At this point the usual active investing warnings apply. Most investors think they are better than average at picking stocks, driving and sex. They can’t all be right, we can’t all be above average. Most people are not wired to be able to control their emotions and biases when stockpicking and most never do the emotional “work” required for this.
As I’ve said before, The Escape Artist is unusual in some ways. Perhaps this is why my teachers at school said I was “special”. Unless you are special as well, you may be better off sticking to passive investing via index trackers.
2. You are allowed to buy international trackers from Vanguard
You may be intimidated by the thought of choosing individual shares or have under-performed trying to do this in the past.
Or you may decide that stock picking is time consuming and you’ve got better things to do with your time. That’s fine…but either way you need to avoid getting stuck with too much cash and not enough exposure to real, wealth generating assets like equities.
Many (most?) investors around the world overweight their ‘home’ market. The UK represents only about 7% of world equity markets, but I know from giving financial coaching that the proportion of home listed shares in an investor’s portfolios is often over 50%.
If your portfolio looks like that, then you are running unnecessary risks. The simplest way to avoid home bias and Stick It To The Man with global equity investing is via index trackers. For the lowest ongoing charges, Vanguard’s ETFs have a slight edge on traditional funds as long as you avoid the temptation to over-trade.
For the passive investing purist, the Vanguard All-World ETF (VWRL) gives exposure to the entire global equity market weighted by market cap. This is like a one-stop shop for international equity investing and might be the only index tracker you’ll ever need.
For those that are a bit concerned about the current CAPE on the US market and buying into Facetweeter and other pre-profit tech stocks at 300x revenues, the Vanguard All-World High Dividend Yield ETF (VHYL) screens out the non-dividend paying stocks and reduces the proportion of US stocks down from over 50% to about 40%.
Either VWRL or VHYL seem like logical options to me. The fees are amongst the lowest on the market (0.25% and 0.29% per year respectively) and we get instant global diversification and equity exposure with a few clicks of a mouse.
I hope this has persuaded you that international investing can be made really simple. There is no need to get screwed by financial advisers, wealth managers and active fund managers with their ridiculously high charges based on % of fees under management.
You can’t complain about inequality and City bonuses etc if you are paying active fund management charges; in that case you are acting as an enabler. If you want to get rich and help spread the benefits of capitalism more fairly, the answer is right in front of you. Dump them.
3. Long term equity market returns are similar in the UK and USA
Let’s assume for these purposes that the US economy is more vibrant than that of the UK. Let’s also assume that translates into faster earnings growth for US listed companies.
This does not mean that future US equity returns will be higher. If the market expects higher future US earnings growth, then this will get reflected (discounted) in share prices on both sides of the Atlantic. If markets are broadly efficient, share prices should adjust to the point where UK shares offer a comparable risk adjusted return. There are plenty of international investors out there arbitraging away anomalies between different equity markets. This is the main reason why US and UK long term equity returns are similar. Another reason is that most companies in the S&P 500 and in the FTSE 100 are large businesses operating internationally and globalisation leads to convergence of international economic returns.
According to the Credit Suisse Global Investment Returns yearbook, the annualised real return on equities between 1965 and 2014 was 6.2% for UK equities versus 5.7% for US equities. If you go further back and look at equity returns between 1900 and 2014, the US noses ahead with 6.5% per year versus 5.3% for the UK. The point is that the differences are not huge (although the effect of compounding is striking over long periods) and depend on the measurement period.
At this point in the debate, someone who has read Fooled by Randomness usually brings up survivorship bias and the long term performance of the Russian stockmarket post 1917. Yes its true that we may have got lucky and that war, communism and Zombie Apocalypse are bad for equity returns.
But this only adds to the argument why we should all diversify internationally.
I’d love to hear from anyone that still thinks that investing is too hard to manage your own portfolio…leave a comment below or email me on TEA@theescapeartist.me
p.s. At last! London FI meet ups…see Facebook link here