Domestic vs International Stocks: Finding the Right Global Allocation

Historical Performance Cycles: US vs International

The alternating performance cycles between US and international stocks have been remarkably persistent over the past 50+ years. From 1970-1989, international stocks (MSCI EAFE) returned 14% annualized vs 10% for the S&P 500, driven by a weakening US dollar, faster economic growth in Europe and Japan, and lower starting valuations for international stocks. From 1990-1999, US stocks returned 18% annualized vs 7% for international stocks, as the US technology boom, falling interest rates, and strong dollar drove a historic bull market. From 2000-2009, the lost decade for US stocks, international stocks returned 15% annualized vs -1% for US stocks, as the US suffered the dot-com crash, financial crisis, and a weakening dollar. From 2010-2023, US stocks returned 14% annualized vs 5% for international stocks, driven by US technology dominance, falling US interest rates, and stronger US economic growth. The full 54-year period shows approximately equal returns for US and international stocks, but with dramatically different timing. An investor who held only US stocks from 1970-1989 underperformed significantly. An investor who held only international stocks from 2010-2023 also underperformed. Diversification across both markets reduces the risk of being in the wrong market at the wrong time. International stock ETFs →

Currency Effects: An Often-Overlooked Factor

Currency movements are a major driver of international stock returns for US-based investors. When the US dollar weakens, international stocks get a currency boost because foreign earnings are worth more in dollar terms. When the dollar strengthens, international returns are reduced. From 2000-2009, the dollar fell by approximately 40% against a basket of major currencies, which contributed significantly to international stocks' 15% annualized return. From 2010-2023, the dollar strengthened by approximately 30%, reducing international returns by approximately 2% annually. Currency effects can dominate stock returns over periods of 5-10 years, making international investing partially a currency bet. Some investors hedge currency exposure to isolate stock returns from currency movements. Currency-hedged international ETFs (like HEFA or DXUS) eliminate currency effects but add costs and complexity. For long-term investors, currency fluctuations tend to be neutral over very long periods because purchasing power parity converges over decades. However, the time horizon for purchasing power parity convergence is highly uncertain, and currencies can deviate from fair value for extended periods. Most financial advisors recommend using unhedged international ETFs for long-term portfolios and accepting currency volatility as a source of diversification. Currency hedging guide →

Sector Composition: The Structural Difference

US and international stock markets have fundamentally different sector compositions. The US stock market is dominated by technology (30% of the S&P 500), communication services, and health care. International stock markets (developed ex-US) are more heavily weighted toward financials (20%), industrials (15%), and consumer staples. The MSCI EAFE index has approximately 5% technology weight versus the S&P 500's 30%. This sector difference explains a significant portion of the performance gap between US and international stocks over the past 15 years, as technology stocks led the global market. International indexes have more exposure to value-oriented sectors like banks, insurance, and manufacturing, which have underperformed. They also have more exposure to small-cap and mid-cap companies, which are underrepresented in US indexes due to the dominance of mega-cap tech companies. The sector composition difference means that US and international stocks provide different risk exposures. A portfolio with both US and international stocks has more balanced sector exposure than a US-only portfolio, which is heavily dependent on the performance of a handful of technology companies. Stock market sectors guide →

Home Country Bias: Why Investors Overweight Domestic Stocks

Home country bias — the tendency for investors to overweight their domestic market — is one of the most persistent behavioral biases in investing. US investors typically allocate 70-80% of their equity portfolio to US stocks, even though the US represents approximately 60% of the global stock market. The bias is even stronger in other countries: Japanese investors hold 70% Japanese stocks (Japan is 6% of global market), and UK investors hold 50% UK stocks (UK is 4% of global market). The rational arguments for home country bias include: familiarity with domestic companies, lower transaction costs, favorable tax treatment of domestic dividends, and reduced currency risk. However, the behavioral explanation — overconfidence in domestic markets and anchoring to recent US outperformance — is likely the dominant factor. The academic literature suggests that the optimal global allocation is approximately 50-70% domestic and 30-50% international, adjusted for investor-specific factors like tax situation, spending needs in domestic currency, and comfort with foreign markets. Going from 0% to 20% international provides the most diversification benefit; going beyond 50% international provides diminishing additional diversification. Asset allocation by goal →

How much international stock should I own?

The optimal international allocation depends on your investment philosophy and risk tolerance. The market-cap-weight approach would suggest owning approximately 40% international (matching the US share of global stock markets). The home country bias approach suggests 20-30% international for most US investors. The global portfolio approach, recommended by Vanguard and BlackRock, suggests 30-40% international for long-term investors. Jack Bogle, founder of Vanguard, famously argued that US investors need no international exposure because US companies already have significant international revenue. However, research shows that international diversification reduces portfolio volatility by 10-15% and reduces the risk of extended underperformance. A reasonable starting point is 30% international for most US investors, with adjustments based on your comfort level, time horizon, and spending needs. For investors with significant spending in foreign currencies (e.g., planned overseas retirement), higher international allocations make sense. For investors with short time horizons, lower international allocations may be appropriate to avoid currency volatility. Three-fund portfolio with international exposure →

Should I invest in developed or emerging markets?

Within international stocks, the split between developed markets (Europe, Japan, Australia, Canada) and emerging markets (China, India, Brazil, Taiwan, South Korea) depends on your risk tolerance and return expectations. Developed international stocks (VEA, SCHF) have lower volatility, higher dividend yields, and better corporate governance than emerging market stocks (VWO, IEMG). Emerging markets offer higher growth potential and lower valuations but come with currency risk, political risk, and weaker shareholder protections. Historically, developed and emerging markets have had similar long-term returns (approximately 7-9% annualized), but with much higher volatility for emerging markets. A typical international allocation is 70-80% developed and 20-30% emerging markets, which approximates the market-cap weights. For investors with higher risk tolerance, an emerging market overweight may add value over long periods, but the tracking error (deviation from developed market returns) can be significant. Avoid allocating more than 10-15% of your total portfolio to emerging markets unless you have significant conviction in emerging market growth and can tolerate 50%+ drawdowns.

How do I invest in international stocks?

The most efficient way to invest in international stocks is through low-cost, broadly diversified ETFs. For total international exposure, the most popular options are VXUS (Vanguard Total International Stock ETF, 0.07% ER) and IXUS (iShares Core MSCI Total International Stock ETF, 0.07% ER). Both include developed and emerging markets at market weight. For developed markets only, VEA (Vanguard FTSE Developed Markets ETF, 0.05% ER) and SCHF (Schwab International Equity ETF, 0.06% ER) are excellent options. For emerging markets, VWO (Vanguard FTSE Emerging Markets ETF, 0.08% ER) and IEMG (iShares Core MSCI Emerging Markets ETF, 0.09% ER) are the leaders. For tax efficiency, international ETFs are generally less tax-efficient than US ETFs due to foreign tax withholding on dividends. International ETFs are best held in taxable accounts to claim the foreign tax credit. In tax-advantaged accounts, you cannot claim the foreign tax credit, so you lose a small amount of return. A common approach is to hold international ETFs in taxable accounts and US ETFs in retirement accounts to maximize tax efficiency. Best international stock ETFs →

Will international stocks outperform US stocks again?

No one can predict with certainty when international stocks will outperform US stocks, but the conditions for international outperformance are becoming more favorable. International stocks currently trade at lower valuations than US stocks (P/E of approximately 14 vs 23 for the S&P 500). The US dollar is at elevated levels by historical standards, and a weakening dollar would boost international returns. International markets have higher dividend yields (3% vs 1.5% for US stocks) and more value-oriented exposure, which could benefit from mean reversion. However, these conditions have been present for years without triggering a sustained period of international outperformance. The uncertainty around when the cycle will turn is precisely why diversification is important — if we knew when international would outperform, we would all shift our allocation accordingly. The key insight is not to predict the turn but to hold a diversified portfolio that will benefit from international outperformance when it eventually occurs, just as you benefited from US outperformance over the past 15 years.

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