Ignoring International Investments – Is Ian an Idiot?

Hi everyone, Ian here again!

That title might be a little harsh, but some of you are no doubt asking the question if you read my original post!

I’ve previously explained my strategy for index investing, which involves sticking to my home country of Australia.

You may be wondering, why on earth would I restrict myself to a region that only makes up around 3% of the world equity markets? Am I lazy? Patriotic? Or just plain ignorant?

Fair questions, but I actually have two reasons – and I’ll let you judge whether they’re compelling enough…

1) I’m Not Convinced Global Will Perform Better

History is always a useful starting point to set the scene. How has Australia fared over the years compared with the rest of the world?

I absolutely love this interactive chart from Vanguard. It allows you to compare the growth of $10,000 invested in different asset classes over any historic period since 1970. I’ve focused on shares in three different regions – Australia, US, and International – over a few different periods.

Let’s start with the performance since 2010:

(PS – that little straight line at the bottom is cash)

Wow, perhaps I am an idiot! Australia’s performance has been woeful!

And look at the US go! No wonder some people are Fearful of a Financial Market Free Fall from this sky-high level!

What about if we go back another 10 years:

Ah, now it’s Australia’s time to shine! We’ve dominated the US and International since 2000, even with the US going gangbusters in recent years!

Does this make Australia the best market to invest in? Perhaps we need to go back another 10 years:

D’oh! The US is back on top again. But Australia still performed excellently compared with the rest of the world! Perhaps we should ignore the rest of the world, but consider the US?

OK, now we’ve nearly gone back to when little Frankie entered the world! Imagine if his parents had put aside $10,000 for him on his birth, and invested in the US market – he’d just about be a millionaire by now, without having to do a single thing!

Let’s take one final step back in time, to 1970…

Wow, total US domination! Australia just has its nose ahead of the rest of the world.

As an aside – Isn’t It Incredible what an extra 1% or 2% annual return can do to your portfolio!!

And – Isn’t It Incredible what an extra 10 years can do to your portfolio!!!!

Of course, this is all based on returns to the end of 2017. There are thousands of different time periods we could look at, but I’m not convinced we’ll find any magic answers by looking even harder (but I encourage you to play around with this, and slice and dice it as many ways as you can!)

So – which market will outperform in the next 10 years? 20 years? 50 years?

Franked if I know!

Go deeper?

What about within the ‘International shares’? Perhaps there are some ‘up and coming’ economies that have outperformed the rest over the long-run?

If not, perhaps there’s a way to know which regions are best to invest in at certain points in time? Dancing around the world following the hottest markets?

Many of you out there are no doubt far smarter than I am. Perhaps you can make better sense of the complex statistics and drivers that push these individual economies forward.

Alas, I am but a simple man. I have no super powers of prediction. I just want a sensible, smart investment plan that plays to my strengths, and uses any small advantages I can get.

So why focus on Australia?

Why not just pick some countries at random, or stick with a truly global fund? After all, Modern Portfolio Theory says that I can get a better risk-return trade-off by diversifying globally:

Everyone talks about the ‘home bias’ when it comes to investing. But the fact is, Australia actually gives me a slight home ground advantage…

2) Free Franking Credits (and it’s actual cash!)

Tax can have a massive impact on your net returns. Now, I don’t know many people that love that word tax, but here in Australia, it’s a beautiful thing where you’re talking about Franking Credits.

Would an extra 1.5% or 2% return per annum for no extra risk tempt you to stick to the Australian market? That’s what Franking Credits can potentially do for us here in Australia (here’s a simple picture of how it works).

And if you look back at the charts above, you’ll see the incredible power of an incremental 1.5% or 2% return each year!

So where do I get these figures of 1.5% to 2% from?

Based on the charts above, let’s run with 9% per annum as a long-term return for Australia.

Australian businesses tend to be relatively generous with paying out dividends. Depending on the time period you look at, dividends have made up around 50% to 70% of total returns.

Australian dividend yields have averaged around 4% to 5% (excluding Franking Credits), again, depending on what period you look at. Let’s run with an average 4.5% dividend yield. The chart opposite shows the incremental benefit of Franking Credits, assuming 100% Franking (which is the case for most individual shares), or 80% Franking (approximate franking for the ASX 300 Index).

Tax shouldn’t be the primary driver for investment decisions – but where it provides a significant advantage, it definitely shouldn’t be ignored. It’s one area that can take the biggest chunk out of your returns if not managed properly.

So am I prepared to give up a potential 1.5% to 2% incremental return for the benefit of global diversification?

There’s no right or wrong answer here, but for me, the answer is NO. I’ll back the Australian market to keep up with the rest of the world – or within 1.5% to 2% – and collect those tasty tax credits at the end of every year.

 

Are you an economic expert, or international market guru? If so, how do you analyse different markets and geographies to determine where to invest? For our international readers, do you have any compelling benefits, tax or otherwise, of investing in your own backyard?

8 Comments

  1. Hi Frankie, I prefer global exposure and do have it in my investments, but I have a heavy home country US bias like you do for AUS. I get my foreign exposure through US multinationals and foreign niche mutual funds. As a graduate business school teacher, I love the modern portfolio theory chart. Tom

    • Ian

      Hi Tom, yes I think you are lucky to have US companies that are multinationals and have global exposure. There are only a few Australian companies in that category unfortunately.

      Must admit I did enjoy dusting off the old university text books to draw that chart… perhaps Frankie can dive in even deeper and start talking about asset betas, CAPM and other fun ‘stock specific’ theory!

  2. I agree with Tom. I do have international exposure at 30% of my portfolio. But, my major investments are in the US market. I had Australia has never had a recession. Something I need to keep in mind while investing 🙂

    • Ian

      Hi Div Geek, I expected that would be the case for you, with your recent posts around international mutual funds and ETFs. The US has some great innovative companies – I’d love if we had a few of those based here in Australia.

      We have gone around 25 years or so without a ‘technical’ recession – perhaps we will be the resilient region if and when markets start plummeting…

  3. Got it. Now, do you have a sense as to when (if) you’d migrate from fully franked to partially franked (or unfranked) dividends? Yield, Growth or Total Return scenarios – or not at all? Or what is the break point (yield wise) that would be of interest? I run (US based) at about 15-20% international (no ETFs) across 12 countries (including Australia).

    • Ian

      Hi Charlie – good question. At this stage I think my decision might be more related to portfolio size than anything else. Once it gets large enough (whatever ‘large enough’ means – but significantly larger than today!), I might consider diversifying further outside Australia.

      I like your thoughts on yield too – this is obviously what is providing the ‘home ground’ advantage. I think yields would have to fall below 2% or so to start swaying me – which I don’t think will happen in the Australian market any time soon.

  4. Fully agree with your sentiments! The cashflow from Australian dividends is too compelling to ignore. I hate it when franking isn’t included in return calculations. If they ever change the system and take it away, then fine. But until then, it’s real cash as you say.

    Especially for those with a smaller portfolio, low tax environment, it makes a lot of sense. Once you start hitting higher tax brackets, then low yield/high dividend growth becomes more attractive than higher yield/lower dividend growth. At that point, it can make sense to look overseas where companies may be able to grow their earnings, therefore dividends much faster – leading to a higher overall after-tax return.

    Makes more sense to focus on the building income stream first in my view, think we agree on that!

    • Ian

      Thanks SMA – good to know there’s at least 1 person out there who definitely doesn’t think I’m an idiot!

      The strategy may change in the future, but given the small size and nil tax in this account (which means bonus cash credits from the tax office!), I think I’m a long way from leaving my home country!

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