I try to shop locally because I think it’s important to support neighborhood businesses. I also cheer for local teams such as the Eagles and Phillies, as long as they aren’t impacting my childhood loyalties to the Boston Red Sox and the New York Giants. Some would call all this a preference for what’s familiar—or, as it’s known in the financial world, “home bias.”
Several Vanguard researchers recently finished a paper on the role of home bias in asset allocation across four different developed markets: the United States, United Kingdom, Canada, and Australia. They found that investors do indeed display a strong home bias.
There was a dramatic difference between the total investments by investors in their home country’s securities when compared to the actual percentage weighting of each country’s market in the overall global market. For example, they found that in 2010, on average, U.S. investors were overweighted in U.S. stocks by approximately 29%. Market capitalization for U.S. equities was actually 43% at that time. So U.S. investors allocated 72% of their equity holdings to domestic securities. That’s a definite preference for the home team. There were similar results in other countries, and the home bias in domestic fixed income markets was even more striking.
There’s a rational basis for at least some of the results. Investors are typically more optimistic in their expectations for future returns in their home markets. Generally, they have a preference for the familiar and more optimism about their domestic economy than foreign investors. Another reason for home bias is the often mentioned concern that investing in foreign investments is inherently more risky than investing in domestic holdings.
There can be myriad factors impacting an investor’s decision regarding asset allocation—home bias being only one. But it’s always helpful to challenge your inherent assumptions to make sure you’ve at least considered alternatives that may assist you in reaching your investment objectives.
Have you considered how home bias may be impacting your portfolio? Do you periodically assess your asset allocation, not only in reference to your personal objectives, basic investment philosophy, and risk tolerance, but also global diversification as well? Do you prefer to invest in domestic securities despite the recognized diversification benefits of global portfolios?
Notes: All investing is subject to risk, including possible loss of principal. Diversification does not ensure a profit or protect against a loss in a declining market. Foreign investing involves additional risks including currency fluctuations and political uncertainty.
Vanguard Research: The global case for strategic asset allocation, July 2012. Daniel W. Wallick, Julieann Shanahan, CFA, Christos Tasopoulos, Joanne Yoon.