International investing is Easy

financial independence

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…

 

globe-of-flags

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.

  1. 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.
  1. Most of the US companies in my portfolio return more cash to shareholders via share buybacks than they do via dividends.
  1. 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

23 comments

  1. This feels like incredibly sound advice for US investors as well — diversify! look at the whole world, not just our own national economy! Thank you for spelling it all out.

  2. The main advice here for everybody: diversify, diversify, diversify. don’t fall in the trap of the home bias. Make sure you get global exposure.

    You also nail it by saying that a lot of companies today are global companies in fact. I think there are few big companies in the FTSE100 or BEL20 that only operate in the UK or Belgium.

    There are indeed no barriers… nothing is holding us back from investing in the markets that we want. In most markets we can invest directly or via trackers.

    Myself, I go for world coverage with 3 trackers, optimised for Belgium.

    good luck with your global investing! lets meet at the end of our journey

    1. …or even before the end! Thanks for the comment.

  3. I think for many who are just starting out on the road to financial independence, a one-stop-shop such as the Vanguard funds you mention, is an ideal solution to the first-time investing quandary. It provides exposure to global equity markets, is simple, cheap and easily understood. That way, the newbie gains exposure to equity growth without having to spend endless hours trying to understand more than they might actually be interested in. It certainly works for me!
    As ever, a great article. Keep it up TEA.

  4. Underscored · · Reply

    Hi TEA, have you had a look at this? Factor based investing in good, cheap and improving? Would like to hear your perspective: https://www.youtube.com/watch?v=VtHgyW18dP0

    1. Underscored – No, I don’t use that product so I cant comment on it specifically. I have however seen other equity market screening software that allows you to rank companies by various criteria. All I’d say is that most investors would be better off focusing on cost minimisation and simplicity rather than paying for specialist investing software.

      There are also free screening products out there that meet most active investors needs. I’d repeat that most people are probably best off sticking with low cost trackers.

  5. Nice post, TEA.

    As you know, I have been pondering on how best to invest in the US and Europe more broadly. you’re definitely right that looking beyond the home bias towards other non-UK companies is a important thing to consider. Over time I expect my non-UK investments to fatten up a little. Watch this space!

  6. many thanks TEA
    im abit too home bias so should up my ex uk exposure
    I have a some uk direct held shares and trackers / ETF,s are great for global exposure.

  7. The Big Monkey · · Reply

    A great post TEA.

    By applying the 4% SWR myself and the good lady are within a year of being FI. If we also look at your last post, we probably need less cash than we think anyway. This was something that I suspected.

    i need to crack on with portfolio now.

    1. Welcome to the Free World!

  8. After making a few investments in foreign companies without realising about the FX commission…I eventually realised, and was well pissed off, and promptly changed my broker, The only problem the charge applies to any future sale too…

    Cheers, Nick

    1. Good news…there is a way to avoid the FX commission on a future sale…by requesting a transfer out of that stock to your new broker. So you don’t sell your foreign company stock via the parasitic broker with the FX commission, you transfer / re-register it to your new broker (eg Share Centre) that don’t charge the commission thereby avoiding the charge on a future sale. When I did this, Share Centre even refunded me the exit charge levied by my old broker…result!

  9. I agree on the principle of diversifying globally. Most of my overseas money is actually via Investment Trusts.

    I also have a few direct overseas holdings. BEWARE of costs though. By far and away the largest trading cost can be the forex loading. TD Direct charge 2%. So if you buy an overseas stock and sell it, that’s 4% gone.

    If you make a modest £5k trade, that’s £100 on forex losses when buying, £100 when selling.
    The trading fee, £12.95 or whatever it is, well who really cares, is insignificant in comparison with the forex charge!

    They clearly hope most customers do not notice.

    1. I’m feeling your pain Jeff. Screw that FX nonsense…by choosing a broker that doesn’t charge it!

  10. Cool TEA. I just wish that we had the ability to invest directly in a single global account in any stock in the world. I wonder how long it will be until we are able to do that. That’s the only thing keeping some of my money in funds like EM and small cap Europe. Transactions costs so high otherwise

  11. Any difference in picking a Vanguard ETF denominated in GBP vs USD? I would assume the performance, volatility etc would be the same and this would just be gaming the currency?

    1. GBP denominated ETFs better for UK investors…matches their spending and avoids sneaky hidden broker FX spreads

      1. I have a etf portfolio not dissimilar to the Simplicity portfolio. The weird thing is the portfolio has gone up post Brexit but with the devaluation of the pound, I don’t know whether I am in a better position or not. It’s a crazy world out there. And I still don’t understand how the world works!?!

  12. Yep, that’s exactly the outcome in the LCIL household…. The weakened pound has lifted my (albeit limited) direct company US stock exposure, & my larger Vanguard Lifestrategy holdings have more than offset the (smaller £) losses i have seen on my relatively smaller FTSE/UK holdings.

    I also have some work related stock options that are in US$ so they have just grown massively too!

  13. Is it ‘fair’ to look at the value of an internationally diversified portfolio in pounds? I am seeing different attitudes to this in different blog comments under the current circumstances and I can’t quite make my mind up if this is deceiving oneself (the pound is worth 10% less than it was) or not (prices may go up due to weak pound, but nevertheless as a UK dweller pounds are what I need to buy goods and services). I suspect there’s no one right answer here, but would be interested in people’s thoughts.

  14. The 4% safe withdrawal rate should come with a health warning. The rule is an oversimplification of work that:

    Ignored the effect of investment expenses
    Ignored the effect of taxes
    Assumed a 30-year retirement
    Assumed a particular US stocks and bonds portfolio during a period when the US outperformed most other world economies

    Take a look at:
    http://www.fa-mag.com/news/why-4–could-fail-22881.html?section=47

    http://retirementresearcher.com/the-shocking-international-experience-of-the-4-rule/

    A globally diversified portfolio did not perform as well as US assets
    Most interpretations of the SWR assume a failure rate: up to 10%
    If you require your nest egg to last longer than 30-years then the SWR goes down
    Costs and taxes drag it down
    If your expenses are in sterling then it makes sense to bias your portfolio to sterling in the deaccumulation phase to avoid currency risk
    A number of authoritative US commentators question the 4% rule as an artefact of a possible golden age for US securities and in light of today’s low valuations i.e. they think it’s anything but safe.

    It is possible to use the 4% rule as a guideline as long as you’re aware it’s not safe, take into account the ignored realities (positive and negative) and especially if you have the leeway to cut expenses or tap other sources of income if stocks go on a bad run. It helps if you’re not planning to stick around for 30 years too 😉

    1. Thanks TA. Health warning duly noted.

      I think the financial benefits of an early death may have been somewhat over-emphasised in the personal finance community. 😉

      And, having reached financial independence a couple of years ago and spent plenty of time chillaxing since then, the SWR assumption of never earning any money again strikes me as unrealistic.

      I’m no MMM but even I have been able to earn some money since I “retired”. My wife also continues to flagrantly disregard all advice to sit around doing nothing. I read recently that Ermine’s been at it too!

      Someone should definitely call the Internet Retirement Police

  15. Jaizan · · Reply

    I have about 85% of my portfolio “overseas”, via Investment Trusts and stocks.

    However, whilst that might protect against a falling pound, it would not protect against currency controls or a communist government.
    I think we had currency controls up until 1979 and I cannot be sure they would not be reintroduced again during my lifetime, in the event of major economic problems. An overseas broker account & linked bank account is needed to fix that one.

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