If you are investing for retirement, you probably own shares in foreign and domestic stocks and bonds. In this article, I explain why that might not be the best approach.
In short, US stocks will generally outperform other investments. If you are investing in international stocks and bonds – or even US bonds – you are probably killing your returns.
Before diving into to this, you might be thinking: “Aren’t you supposed to invest in bonds and international holdings in order to be properly diversified?”
Well, not necessarily.
International stocks might be worth considering (which I’ll explain later), but most of the time international stocks are going to give you mediocre returns.
Before we get into that, let’s first talk about US bonds, since those, too, could be killing your returns.
According to Investopedia,
A U.S. savings bond is a government bond offered to its citizens to help fund federal spending, and which provides savers with a guaranteed, although modest, return.
The key takeaway from this definition, I think, is “modest return.”
When I talk about bonds, I’m usually referring to bond funds – the type of bonds you would expect to have in a 401(k) or IRA.
I’m not talking about individual savings bonds as defined above, although there isn’t much difference between the two in regards to how they perform.
The whole issue with bonds is that they don’t perform as good as the stock market does – plain and simple.
If you have bond funds in your investment portfolio, they simply won’t yield very good returns – so this ends up hurting your overall rate of return.
Some people own bonds because they think they are “safe” or “diversified,” but that will usually cost them.
Here is an example of a US Vanguard Bond Fund and how it compares to the overall market (or S&P 500 Index).
As you can see, the market is getting way better returns; the bond fund is essentially flat.
International bonds are similar to US bonds in that they are issued by corporations and governments, but they are issued to foreign investors.
For example, a US resident would be a foreign investor in bonds issued by countries outside of the US, and vice versa.
Like US bonds, international bonds perform poorly when compared to the stock market.
Here is an example of a Vanguard International Bond Index Fund and how it compares to the S&P 500 (stock market).
Once again, the international bond market cannot compete with the stock market.
Many people have international bonds in their investment portfolio, and they may be unaware of their poor performance. This is worth looking into.
Having shares in bond funds of any kind – whether foreign or domestic – could be hurting your overall returns.
Personally, I don’t think bond funds are worth it. People think they’re safe and diversified, but that might cost them.
If international bond funds are less than ideal, what about international stocks?
We’ll look at those next.
Simply put, international stocks are issued by companies outside the US.
Some financial experts encourage investors to own international stocks for diversification, but that’s not always a good idea.
Sometimes you can get exposure to international stocks by investing in international stock funds – or mutual funds. I generally prefer mutual funds because they aren’t as risky as individual stocks.
In contrast to international bond funds – or even US bond funds – international stock funds can get you good returns.
The problem is, however, they are hard to find.
I don’t doubt that there are some good international stock funds out there; I just don’t have access to any through the brokers I use.
In fact, most of the international stock funds I have seen, perform similar to the Vanguard international stock fund below.
Here is a screen shot of how it compares to the S&P 500.
Once again, it loses badly to the US stock market.
That is not to say that international stock funds can’t beat the S&P; it’s just that I haven’t been able to find any.
The screenshot above is a common example of what I find to be true most of the time: international stocks don’t perform as well as US stocks – which leads me to my next point.
Investing in US stocks
Investing in US stocks is, perhaps, the best thing to do if your goal is to get the best returns you can.
That’s right – 100% US stocks, baby!
This should go without saying – but when I say US stocks, I’m referring to US stocks in mutual funds, since mutual funds mitigate risk.
Mutual funds allow you to hold shares in multiple companies, and that’s how lower risk is achieved.
For example, if some companies lose value, while other companies gain value, that might allow you to still come out ahead.
This is precisely what has happened, historically, with the S&P 500 (500 of the largest companies in the US).
Historically, the 30-year return of the S&P 500 has been about 12%.
So, if one year the S&P 500 is plus 20% and the next year it’s down minus 5%, that’s still an average increase of 7.5% over those 2 years.
That means – if you stay invested for those 2 years, you didn’t lose anything. You actually gained, and that’s what you can expect when you invest in US company stocks.
That’s also why the S&P 500 is a good indicator of how well the stock market is doing overall.
If the S&P is up, your investments are probably up, especially if invested in US stock mutual funds.
There are a lot of mutual funds that mimic the returns of the S&P 500; those would be considered good funds, in my opinion.
However, there are other funds that won’t even do that, so I would try to avoid those.
By the way, here’s how the VTSAX matches up to the S&P 500 – they are all but identical.
Occasionally, you might find funds in US stocks that beat the S&P 500, so those are even better!
For example, the Vanguard Growth Index Fund is one of them.
If you are able to find mutual funds in US stocks that match or beat the S&P 500, you are in good shape. At the very least, you can expect a 12% return – which is not bad at all.
Why it matters
If you are able to match or beat the S&P 500, you can easily become rich overtime.
However, if you invest in bonds or poor performing international stocks, your returns will likely suffer.
By investing 15% of your income in US stock funds, you will likely have millions of dollars when it’s time to retire.
You can use this investment calculator to figure those numbers.