It’s understandable that many UK retail investors only want to invest in UK-listed stocks. Familiarity can be comforting and placing your faith (and cash) in companies you’ve never heard of feels decidedly riskier.
Today, however, I’m going to show you just how ‘home bias’ can compromise returns by comparing the performance of the FTSE 100 over 2019 with another major index.
A great year but…
At the beginning of the year, the FTSE 100 was at 6,734 after a fresh bout of Brexit uncertainty hit stocks in the final quarter of 2018. Following last week’s election outcome (and perceived breakthrough on our EU departure) it closed yesterday at 7,525. This represents an impressive 11.8% gain.
But now let’s compare this to the performance of the S&P 500 — the index of the 500 largest companies in the US.
Over the same period, and despite/because of the Twitter ramblings of Donald Trump, this is up a stonking 27%. Even with its generous dividend yield, this leaves the FTSE 100 very much in second place.
Not even costs can dent the S&P’s margin of victory by much. The difference in ongoing fees of holding an exchange-traded fund tracking each market is negligible.
Should I avoid UK stocks then?
Absolutely not! While the performance of US equities has been far better over 2019, there are a couple of reasons why we need to be cautious when evaluating this performance.
First, hindsight is a wonderful thing. No one knew where markets were going at the start of 2019. No one knows where they’re going in 2020 either.
Second, the outperformance of the US market in 2019 means that it continues to be ‘priced to perfection’, or at least is far more expensive compared to other markets. Having traded within a range for most of the year as a result of Brexit jitters, UK equities were and are far cheaper by comparison. If one were inclined towards value rather than momentum — and academic studies suggest, over the long term, we should be — the UK might still represent a better investment over the long term.
So, what are you saying?
The lesson from all this is simply that depending on one stock market/index for returns guarantees the opportunity cost of missing out on gains elsewhere. By having at least some of your capital invested in shares listed overseas, you give yourself the chance of potentially ‘beating’ the FTSE 100 return (and trailing it, of course).
Another benefit of this approach is that it gives you some downside protection. If Boris Johnson had not been victorious last week, it’s highly likely that many investors would have continued to keep their powder dry in the event of a hung parliament or sold whatever they still owned if Labour had won a majority.
In either scenario, we could have been looking at a year-to-date gain of far less than almost 12%. Indeed, such was the nervousness in the City over the possibility of a Labour government, there was every chance of a negative FTSE 100 return for the year, even though a lot of its constituents make most of their money overseas. The impact on the more UK-focused FTSE 250 would have been even worse.
So, as we enter 2020, consider the benefits of an easy way of diversifying some capital into other markets via passive trackers or a few carefully-selected, UK-run active funds that invest abroad.
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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.