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According to numerous studies, “home bias” is very common amongst investors. UK investors tend to prefer investing in UK equities. The same holds true for US investors and their own market. The reasons for this are numerous including transaction costs, inaccessibility and a sense of unfamiliarity with foreign equities. Yet concentrating your portfolio in your home country presents numerous risks and leads to missed opportunities available abroad. In this article, our Burnley financial advisers explain why diversifying beyond home borders is so important. We hope this is useful to you and please contact us if you want to discuss your financial plan with an experienced financial planner in Padiham.
Why is “home bias” so common amongst investors?
Human beings instinctively fear the unknown. We tend to feel more comfortable dealing with brands that we encounter regularly, sharing our language and culture. This can lead investors towards investing in “home stocks” and avoid companies which seem remote and unfamiliar. Transaction costs can also be a barrier to investing globally. Perhaps investing in foreign stock markets involves higher transaction costs (e.g. greater bid and ask spreads) as well as taxes which may not be levied on home stocks. There may be perceived political risks with investing in certain countries – e.g. nationalisation risk with certain industries – as well as foreign currency exchange risks. However, many of these risks can be navigated effectively with professional financial advice, using a prudent investment strategy.
The risks of succumbing to home bias
The main risk of home bias is that an investor exposes him or herself to a concentration risk. What happens if there is a stock market crash in your home country, for instance? Your portfolio will likely be affected more deeply compared to an investor with a globally-diversified portfolio. There is also the danger of missing out on opportunities elsewhere. No single stock market is the same; each one offers unique features that could complement your holdings. For instance, the US stock market includes many technology companies, with the NASDAQ 100 including the popular “FAANG” stocks (Facebook, Apple, Amazon, Netflix, Google, or Alphabet). The UK stock market, by contrast, is light on technology but offers a lot of companies which pay a high dividend and which offer higher inflation resilience – e.g. financial services and energy. Japan still leads the world in robotics and Europe offers Cyclical, Defensive and Sensitive regions such as basic materials, healthcare and industrials. By investing globally, therefore, an investor can not only mitigate the risks associated with national stock market crashes, but also diversify their portfolio into multiple sectors, industries and markets.
Important notes on global investing
Investors should recognise that, in today’s world, it is difficult to avoid global influences on their portfolios. The companies in the UK’s FTSE 100, for instance, get 75% of their revenues from overseas sources. British Petroleum (BP) serves commercial airlines, business jet operators and aircraft operators across the world – not just in the UK. This feature of the FTSE 100 means that the UK stock market is heavily influenced by foreign currency fluctuations. If the pound sterling (GBP) falls relative to the dollar, then this can benefit FTSE 100 companies earning revenue from overseas currency (since this will be worth more when converted back into pounds). This picture is helpful for investors to realise that they cannot, in fact, “hide” from the world by using home bias as a strategy. Even a portfolio largely consisting of domestic stocks will be impacted by events across the world. Therefore, why not take a stake in these overseas markets?
With this said, currency fluctuations can have a hidden effect on your returns from international investments that can be difficult to discern. For example, suppose you use GBP to buy shares in some US-based stocks (converting into dollars). Suppose these shares rise in value over the coming months, but the US dollar also weakens against GBP in the same period. If you then sell the US shares, it may appear that you have made a return – yet the US dollars will be worth less in GBP, thus diminishing the “real” returns. To account for this risk, it can help to get financial advice – letting you hedge more effectively and avoid overlooking the impact of currency fluctuation on your portfolio.
Investors should also be mindful of the US stock market and how it can impact even a portfolio that is heavily diversified across the world. In 2022, over 60% of world stock market value was based in the US despite relatively poor performance from the S&P 500 and NASDAQ that year. Given its dominance, events in the US markets are likely to have knock-on effects onto UK markets, EU markets and those further afield in Africa and Asia. The US dollar is also the world’s most commonly-traded currency, so its strength relative to other currencies (e.g. affected by Federal Reserve decisions) will also impact domestically-focused investors in other countries. Speak to a financial adviser to better navigate the potential impact of foreign markets on your portfolio, building a diversified asset allocation which mitigates needless risk and maximises opportunity.
Invitation
If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you. Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938
E: info@elmfieldfp.co.uk
