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International investing

Much of the world's investing takes place outside the U.S. By owning international investments, you diversify your portfolio even more.

POINTS TO KNOW

  • Investing in international funds increases your diversification, thus lowering your risk.
  • You can invest in both stocks and bonds internationally.
  • Developed and emerging international markets have different levels of risk and potential return.

Why invest internationally?

You may not be as familiar with the names of companies outside the United States—which might make you feel like the stocks and bonds they issue are overly risky.

But if you invest through international mutual funds or ETFs (exchange-traded funds), you can actually lower the risk in your portfolio, because it's just another means of diversification.

Markets outside the United States don't always rise and fall at the same time as the domestic market, so owning pieces of both can level out some of the volatility in your portfolio.

How much should you invest?

To get the full diversification benefits, we recommend that you consider investing about 40% of your stock allocation in international stocks and about 30% of your bond allocation in international bonds.

For most people, investing internationally through mutual funds or ETFs is a better option.

Not only will you get the benefits of diversification, investing through funds also tends to be cheaper and easier, since you won't have to worry about the costs and timing considerations associated with trading on international exchanges or through American depositary receipts.

Watch and learn with these videos

Is your portfolio worldwide? Hear from our experts on why everyone should have international investments.

The benefits of global investing Stream video

Read a transcript

"Staying home" isn't always the safest option. See how international investing can lower volatility.

Is a global portfolio riskier? Stream video

Read a transcript

How much global exposure is enough? Hear how we developed our targets for international stock and bond allocations.

Vanguard's recommended international allocation Stream video

Read a transcript

Will currency fluctuations harm your international investments? Our experts explain why changes in the strength of the dollar tend to wash out over time.

Does a strong dollar impact a global portfolio? Stream video

Read a transcript

Types of international markets

International markets are generally divided into 2 main categories:

  • Developed markets are located in countries that have established industries, widespread infrastructure, secure economies, and a relatively high standard of living.

    Examples of developed markets include the United Kingdom, Japan, Australia, Canada, and France.
  • Emerging markets are located in countries that have developing capital markets and less-stable economies. However, they're considered to be in the process of transitioning into developed markets, and they may be experiencing rapid growth.

    Examples of emerging markets include India, China, Egypt, South Africa, Mexico, and Russia.

Not surprisingly, developed markets are similar to the United States when it comes to volatility levels and the range of potential returns.

Emerging markets are more volatile than developed markets and have a wider range of potential outcomes. For that reason, we recommend that you don't overweight your allocation to emerging markets. Currently, emerging markets make up about 15% to 20% of international markets in total.

International regions

Many international funds invest across multiple countries within a specific area of the globe, like:

  • Asia-Pacific (Australia, Japan, Hong Kong, Singapore).
  • Europe (United Kingdom, France, Spain, Germany).
  • Latin America (Brazil, Mexico, Argentina, Peru).

Go in-depth with these white papers

Read how the optimal allocation to international stocks has changed over time.

Find out whether currency hedging in stock portfolios can lower risk, add to return, or both.

See some considerations for investors looking to add an international bond allocation to their portfolios.

What's next?

You can research and choose investments individually, but we strongly recommend that most of your portfolio be made up of mutual funds or ETFs.


WE'RE HERE FOR YOU

If you'd like some help with your investing decisions, here are a couple of ways you can get the answers you need.

Get an asset allocation recommendation online. You just need to answer some questions about your time frame, risk preferences, and financial situation.

Partner with a Vanguard advisor. If you'd like a professional to manage your portfolio for you, we can do that. Research shows that an advisor who provides professional financial planning, coaching, and portfolio management services can add meaningful value compared to the average investor experience.*


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REFERENCE CONTENT

Layer opened.

Stock

Usually refers to common stock, which is an investment that represents part ownership in a corporation. Each share of stock is a proportional stake in the corporation's assets and profits.

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Bond

A bond represents a loan made to a corporation or government in exchange for regular interest payments. The bond issuer agrees to pay back the loan by a specific date. Bonds can be traded on the secondary market.

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Mutual fund

A type of investment that pools shareholder money and invests it in a variety of securities. Each investor owns shares of the fund and can buy or sell these shares at any time. Mutual funds are typically more diversified, low-cost, and convenient than investing in individual securities, and they're professionally managed.

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ETF (exchange-traded fund)

A type of investment with characteristics of both mutual funds and individual stocks. ETFs are professionally managed and typically diversified, like mutual funds, but they can be bought and sold at any point during the trading day using straightforward or sophisticated strategies.

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Risk

Usually refers to investment risk, which is a measure of how likely it is that you could lose money in an investment. However, there are other types of risk when it comes to investing.

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Portfolio

The sum total of your investments managed toward a specific goal.

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Diversification

The strategy of investing in multiple asset classes and among many securities in an attempt to lower overall investment risk.

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Market

The trading of a universe of investments, based on factors like supply and demand. For example, the "stock market" refers to the trading of stocks.

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Volatility

The degree to which the value of an investment (or an entire market) fluctuates. The greater the volatility, the greater the difference between the investment's (or market's) high and low prices and the faster those fluctuations occur.

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American depositary receipt

A certificate issued by a U.S. bank that represents one or more shares in a foreign stock. ADRs are denominated in U.S. dollars and traded on U.S. exchanges and hence can be a cheaper and easier way to invest in individual international stocks.

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The benefits of global investing

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The benefits of global investing

Liz Tammaro: Hello everyone, I'm Liz Tammaro, and welcome to this live Google Hangout, held exclusively for you, our Personal Advisor Services clients. Joining me today are two experts from Vanguard's Investment Strategy Group, Scott Donaldson, a senior investment strategist, and Investment Analyst Andrew Patterson. Gentlemen, thank you both for being here tonight.

Scott Donaldson: It's my pleasure.

Andrew Patterson: Thanks, Liz, it's a pleasure.

Liz Tammaro: So tonight we're going to be discussing the global economic landscape, as well as the advantages of global investment portfolios. Please submit your questions for our guests throughout our program. If you're watching us on Google+™, just type your questions into the box, which is located on the right-hand side of your screen, towards the bottom. I'll be able to see your questions here on my computer screen, and we will answer just as many as we can tonight.

So let's go ahead and get started with our first question. So someone sent in and said to us, "Many countries overseas are not secure, and they can change quickly. Why would this investor want to take a chance like that in their investment portfolio?" Andrew, I'm going to give that one to you to start.

Andrew Patterson: Sure, thanks, Liz. So, granted, the U.S. financial markets are some of the most developed in the world; but I wouldn't say that that necessarily makes them less risky, particularly when you compare them to other developed markets. There's going to be ebbs and flows over any given time period, and many times those ebbs and flows are offset by the highs and lows of other financial markets. So your Germanys, your Frances, even getting into emerging markets. It's trying to offset those peaks and valleys with, hopefully, uncorrelated or, rather, negatively correlated financial markets. Now, what I mean by correlation, basically it's when the U.S. market is up, is this other market down? And when the U.S. market is down, is this other market that you've invested in up? So it's trying to offset that and try to balance out the volatility over time.

Liz Tammaro: Okay, so it's not so much about the security or lack thereof in these individual countries. It's about how the investments in all the countries in the world sort of balance each other out.

Andrew Patterson: It's how they interact together. So the benefits of diversification, it's really for a long-term timeframe. You're not in this for a total return perspective. You're not placing bets to increase the return in your portfolio. Again, rather to try to even out those ebbs and flows over time.

Liz Tammaro: Makes sense.

Scott Donaldson: Yeah, and it's interesting, and I think I'll add to what Andrew just said is it's actually that riskiness of some of these non-U.S. countries and that added volatility that actually adds overall to the portfolio that makes the overall portfolio less risky from a volatility standpoint. So having those countries that are more risky than others actually adds the benefit, which seems counterintuitive—

Liz Tammaro: Right.

Scott Donaldson: —but it's kind of a concept of financial and portfolio theory that adds that.

Liz Tammaro: So I'm hearing you say that an individual country that may be perceived to be risky on its own, when brought together in a broad portfolio, actually reduces risk.

Scott Donaldson: Correct. And I think if you actually look long-term at a lot of the data, you actually could see a lot of non-U.S. countries on their own have much higher volatility than the U.S. But when you add them into a portfolio, the overall portfolio volatility is actually less than each individual country and in some cases less than the overall U.S. market or very, very close to it. So it kind of points out to me that by diversifying into all these countries, less risky, more risky, adds somewhat of a diversification effect, and in some ways diversifies specific country risk.

Andrew Patterson: Absolutely.

Liz Tammaro: And so you're talking about the diversification benefit, Scott, and I want to hear your thoughts on is investing internationally or non-U.S. securities in fixed income as important as doing the same thing in equities?

Scott Donaldson: Sure, I mean, the short answer is yes. We do believe it's very, very important; and I think what's interesting is over the years, it doesn't get quite as much attention over, say, ten years ago as it does today. And part of the reason I think is the size of the market of non-U.S. bonds has evolved greatly.

It's roughly doubled, say, in the past 10 years or so as well as, 10 years ago or 15 years ago, the access to that particular market, the liquidity, the transparency of those particular non-U.S. bonds were much, much less then than they are today.* So as those costs, liquidity, and transparency have actually come down over the years and the size has grown, it's become much easier to gain access to that at a lower cost. So it's very, very important, and it adds the same type of dampening of volatility over time that investing in non-U.S. equities does adding them with U.S. equities.

Liz Tammaro: So investors are able to get access to non-U.S. bonds. It's easier today than it has been in the past, and that diversification benefit is as important there as it is for stocks.

Andrew Patterson: Absolutely.

Scott Donaldson: Absolutely, especially considering that it's now the largest financial market in the world.* So not having those bonds in your portfolio, you're excluding a very, very large opportunity set from the global financial markets.

Liz Tammaro: Non-U.S. bonds, the largest asset class.

Scott Donaldson: Yes.

Andrew Patterson: Among bonds and equities, absolutely.

Liz Tammaro: So let's dive into a little bit around portfolio construction here. What percentage of stocks and what percentage of bonds in a portfolio should be invested in non-U.S. markets? What do you guys think?

Andrew Patterson: So research has shown that adding any level of international bonds really helps to reduce volatility within a portfolio. Why is that? Again, as Scott mentioned before, you're aggregating all those different countries. You're aggregating all those different regions, and their bonds have different volatilities that interact, and you have the ebbs and flows counteracting each other. So you aggregate those all up whereas, if you're focused solely in the U.S. and only investing in U.S.-domiciled bonds, then you're only exposed to the ebbs and flows within the U.S. bond market.

You add those other countries in and you're starting to offset some of that risk because again, same type of concept. Over long periods of time, you're not going to see the same types of ebbs and flows in the U.S. fixed income market as you would in international markets, as you would in the Japanese market, the German market, what have you. So it tends to decrease portfolio volatility over time. So any sort of allocation there tends to add benefits.

From an equity perspective, fixed income and equity, rather, we tend to follow a market cap– proportional approach, which is what we advocate, but we understand investors aren't really comfortable doing that all the time. So much like what we did when we advocated for adding international equities, we started low. We started around 20% for fixed income. We've since moved up to around 30% for fixed income.

Equities, they've been in our portfolios. They've been in our advice for some time. Investors are becoming a little bit more comfortable with that. So we've moved, since, from 30% to 40%.

Liz Tammaro: And can I just have you elaborate on what you said around market cap is the recommendation? Can you just explain that a little bit?

Andrew Patterson: Sure. So Scott mentioned before, we talk about different markets across the world, non-U.S. dollar-denominated bonds being the largest of those. It's basically the market value. So the price times the number of shares or the number of bonds, and you get these figures, and then you look at that, and that's your market-cap proportion. So if I have a hundred shares at a thousand dollars, it's a million dollars' worth of market capitalization.

Scott Donaldson: Yeah, and I think adding to what Andrew said and if you think about, for an investor, to kind of put a range or like some guardrails around what they might think are reasonable allocations, in any case, having any international diversification, first and foremost, is the first step. But to kind of get towards a more, what we would view from a portfolio construction standpoint is market-cap weight is, as Andrew pointed out, I think, from the theoretical standpoint, would be a great place, from a forward-looking standpoint, to be at.

However, we also know that there's practical implications that investors deal with, also, on a daily basis. And one of the major practical implications these days is costs of accessing some of these markets. Going international or non-U.S. is more costly than investing in domestic securities both on the stock and the bond side. So moving closer, over time, closer to a market-cap weight certainly is reasonable. But having, as Andrew put on the equity side, at least 40% of your equity allocation and 30% of your fixed income allocation in non-U.S. securities is very important.

I think one thing we haven't talked about here is, on the bond side, is we advocate 100% to hedging the currency risk on fixed income, and we have not talked about that yet. But I think it's important to understand for bonds versus equities that currency risk is part of investing internationally. So you do have the choice of trying to take that risk of volatility from currency movement out. And our research has shown removing it and hedging it out of bonds makes a bond more like a bond, much less risky where you don't hedge the currency. It makes a bond return and volatility, oh, I should say more volatility closer to an equity return with bond characteristics. So very important to reduce that volatility and make a non-U.S. fixed income holding act like fixed income and not a hybrid equity security.

Liz Tammaro: Sure, because bonds are in a portfolio to do a job, right, and that's to sort of stabilize the fluctuation of the equity markets and volatility there.

Scott Donaldson: Correct.

Liz Tammaro: And so what I'm hearing you say is that if you don't hedge the currency in the fixed income space, the bonds act like stocks; therefore, they're not doing their job as stabilizers in a portfolio.

Scott Donaldson: Absolutely, absolutely.

Liz Tammaro: That's a great point. Anything else around the advice? It sounds like what I'm hearing you all say, too, is that we have this global market cap which we advocate towards. There could be some hurdles in practically getting there, but our advice certainly is recommending that investors have international non-U.S. allocations in both fixed income and equities.

Scott Donaldson: Correct. So there is no real exact right answer. It all comes down to sometimes investor comfort. It could be investor by investor, but having a significant portion of your bonds and your equity portfolios invested in non-U.S. securities, certainly in our mind, is very, very important to reduce long-term volatility to the portfolio.

Liz Tammaro: So in still thinking about portfolios that we're building here, should the non-U.S. part of a portfolio, should that be evolving and changing in relationship to your retirement horizon? So what I think I am interpreting out of this question is, maybe for a younger investor, do they have more or less non-U.S. allocations compared to someone who's closer to retirement? What do you guys think about that?

Scott Donaldson: Well, I mean, I'll start out with just saying, first, regardless of your age, younger or older, closer to retirement, the same concept applies, international diversification is very important.

Liz Tammaro: It helps.

Scott Donaldson: It absolutely helps reduce volatility over the long run. It doesn't work every day. It doesn't work every month and so forth but, over time, it should lower volatility. But if you think about it this way, I think we had talked about equities as a general proportional recommendation of, say, 40% of your equity being invested in non-U.S. equity markets, 30% of your non-U.S. bonds being invested in fixed income hedged, okay. Those are roughly important allocations and fairly sizable.

So as a percent of bonds, we think the ratio should stay the same across, no matter how old you are from younger to older. However, as a percent of the total portfolio, okay, as you move towards retirement and you come more out of equities and maybe become more conservative and have more bonds, by default, you own less international on an absolute basis. Okay so—

Liz Tammaro: I see what you're saying.

Scott Donaldson: —a great example there is if you're 100% equity, you're 40% of that in non-U.S., you have a 40% weight. If you're a 50/50 investor at 40%, you've got a total portfolio allocation of only 20%. So, technically speaking, the ratios are the same within the asset classes, but, as a percent of the total, theoretically then, yes, you have less international as your portfolio becomes more conservative.

Liz Tammaro: Right. I follow you here. So as bonds comprise a larger portion of your portfolio, which is prudent for investors as they age, that the international allocation is naturally decreasing a bit because there's a smaller allocation there in the fixed income space.

Scott Donaldson: Correct. So that's an example on the equity side. So the opposite of that is, now, on the bond side, as you grow more conservative and closer to retirement, the total portfolio allocation of your international bonds grows, relative to what it was when you had less bonds. Key is here the ratio should stay the same though, in our view.

Liz Tammaro: Sounds good. So we talked about the diversification benefits, but with foreign economies not performing well or the perception that they're not performing well, why would somebody want to invest in something that's not going to be valuable or add value to the portfolio? Andrew, what are your thoughts on this?

Andrew Patterson: So I think the first thing you need to do there is address the perception that people have that the growth necessarily determines equity returns. So a lot of individuals will talk about, "Well, expectations for growth internationally, they're shaky; they're low, so that means the equity returns are going to be low." Well, that's not necessarily the case.

If my expectations for growth in the euro zone, let's say consensus is somewhere around 1.5% for 2015, and euro zone actually turns out to grow around 2%, well, that's actually a positive event for equities, potentially in the euro zone. Whereas, in China, their growth is expected to be around 7%. Let's say they grow at 6.8%, right. That 6.8% is still greater than the 2% that the euro zone was growing at, but that might actually be a negative event for Chinese equities because it's actually grown less than expectations.

A lot of times, we find that expectations for growth are already baked into equity prices. So it's not so much the growth that's realized, but it's those unexpected shifts in growth, which are, by nature and by their name, unexpected. So this all goes back to the diversification argument and why it pays to hold a wide array of equities, of bonds, of countries, of industries, what have you.

Scott Donaldson: It's funny, and it's kind of the way in such that the investment markets work is you're potentially paid for the amount of risk you take. So when we say bonds or stocks in country X, we don't think they're going to do very well because there's problems over there and so forth, well, the equity markets and the bond markets, in the prices, are reflecting those negative outcomes going forward.

So, theoretically, depending on what price you pay for the forward-looking earnings and investments, ultimately, can be very, very positive and unexpected for many, many people because the risk is there, and you're being paid for taking on that risk.

Liz Tammaro: So if you get a good price per se, right, a good deal in purchasing some of these securities, which they may be discounted if there is the perception of risk around them and there are upside surprises, then that could be a good thing for your portfolio.

Scott Donaldson: Correct.

Andrew Patterson: Absolutely.

Liz Tammaro: So I hear this question quite a bit. You both have convinced me that investing in non-U.S. securities is a good thing, but why wouldn't an investor just focus on investing in U.S.-based multinational companies? Why doesn't that give them enough of a diversification benefit if, in fact, companies that are located here, they have quite a bit of exposure outside of the U.S.? What do you guys think about that?

Andrew Patterson: I'll start off with that one. So what individuals are looking at there is they're really looking at revenue streams, right. So I invest in GE or GM or one of those conglomerates, and they're getting— You hear numbers thrown around, around 40% of their revenue is international.** So shouldn't that diversify me, quote/unquote, "globally" because I'm invested in these multinational firms? That's not necessarily the case because that's just diversifying away your revenue streams. There's other factors at play as well.

So let's say, during the downturn, that GM fared very poorly here in the U.S. Take a counterpart in Germany, let's say, BMW where, in the luxury car market, might have fared a little bit better. Okay, so you have these other factors to consider. It's not just where the revenues are coming from, but what are these country-specific and industry- and stock-specific risks that you're facing that might be offsetting each other? So, again, broad diversification tends to even those out over time.

Scott Donaldson: And I think, too, if you think about— We talked earlier about the size of these markets. So, on the equity side, non-U.S. equities are roughly 50% of the global stock market.*

Liz Tammaro: Wow!

Scott Donaldson: Non-U.S. bonds are even larger. They're about 60% of the entire global bond market.* It's a huge market. So just by saying, "I'm going to invest in GE," for instance, you're automatically, then, excluding global leaders like a Samsung or a Nestle Foods that are not domiciled here in the U.S. but have significant global footprints out there from a corporation standpoint.

And I think the other thing is there has been a lot of research done regarding the correlations and performance of equities, whether they're domiciled, you know, in the U.S. or not. And I think some of the research out there shows that a stock will trade more like where it's listed.

So, for instance, even though you have GE that might have 50% of their revenues overseas or Coca-Cola, for instance, that might have a greater part of their revenues from non-U.S. countries, they trade like they're a U.S. company and they trade like the U.S. market because that's where they're listed on the NY Stock Exchange or what have you.

Liz Tammaro: Where they're listed.

Scott Donaldson: So you do not get the entire benefit of global diversification by investing in just multinational companies.

Andrew Patterson: Price is based, to a large degree, on perceptions.

Scott Donaldson: Correct.

Andrew Patterson: So if I'm a U.S. investor and I'm investing in GE and conditions are poor here in the U.S., I'm not necessarily going to translate the fact that revenues might be higher in Germany into my expectations for stock prices.

And I think something else that gets lost in the discussion as well is actually just flat out the number of shares listed here in the United States. I've seen studies out there wherein, currently, there's actually fewer shares listed today than there were back in the 1970s.

So you had a huge buildup in the early 1990s. So much, much lower on a relative basis and a much, much lower share of the global proportion of listed companies, listed firms.

Liz Tammaro: Sounds good. So we actually have a question that came in from one of our live viewers. Thank you for submitting that. This investor is noticing a negative return on the performance of their international bond funds. How should one overcome this? And, given those negative returns, does it still make sense to be invested in those funds?

Andrew Patterson: So I'll start off with this one. So what the investor may be realizing right now— So, first of all, if you are investing in an international bond fund and you're realizing negative returns, it doesn't necessarily have to be because there's negative yields. A lot of people equate negative yields with negative returns. That can be the case; it doesn't have to be. It depends on where the yields go. If the yields actually move more negatively, there can actually be a positive return because you have a capital appreciation. But we have this discussion with clients a lot where they want to understand why, if I'm investing in short-term German bunds, would I even do so because they have slightly negative yields right now?

Well, if it's a U.S. investor that you're speaking with, it goes back to Scott's discussion around hedging. So if I'm able to hedge, or if I do, rather, as Vanguard does, hedge away that currency risk, you're actually removing the discrepancies between the two yields.

So the way hedging really works is that, over long periods of time, if I'm an investor in the United States and the U.S., let's say the ten-year Treasury is yielding 2%; and the German ten-year treasury, ten-year bund is yielding 1%, there's an arbitrage opportunity there. So what markets will do, what the expectation is to happen is that that's going to— You're going to have a currency return that offsets that such that it moves the return for holding German bunds up in line with that for holding U.S. Treasuries.

So if you're hedging, it's at that instant right then and there that you put that hedge on that you're completely indifferent between investing in negative-yielding German bunds and positive-yielding U.S. Treasury securities. Because of that expectation for the hedge return, you're indifferent at that point in time.

Then you get the movements, like I talked about before, where sometimes they'll move in your favor, sometimes they won't. If you have a decrease in yields, whether it's to even more negative levels or from 2% to 1.5%, you'll get capital appreciation. Whereas, if you have an appreciation in yields, let's use the U.S. as an example, from 2% to 2.5%, you're actually going to realize a negative return there because of the capital losses.

So it's important to make those distinctions with clients that just because they're locking in a negative yield, they're investing in a negative-yielding security, it doesn't mean they have to realize a negative return.

Liz Tammaro: Okay, so— Go ahead, Scott.

Scott Donaldson: And I was going to say, I mean, if you just think about it so looking at, quote, the "headline yields" is not necessarily the whole story. You need to evaluate how's your portfolio being managed? And if it is being hedged back to the local currency, which happens to be a higher-yielding currency or a higher-yielding rate than the non-U.S., which, in this case it is—the U.S. is higher than many, many non-U.S. countries right now—that hedge return or the return associated from the hedging action is usually positive and then makes up the difference in the yields between the two countries over time. It's not going to be every day. It's not going to be every month but, over longer periods of time, there'll be a positive return to that currency hedge.

Liz Tammaro: So we were talking about sort of the theme today, right, is around diversification. And so, for this investor, one element, one piece of their portfolio, the international fixed income space, right, isn't performing as well as the other pieces. But that's the whole point of diversification because it's hard to know which piece is going to be the top performer, which component. Is it going to be the domestic stocks or the non-U.S. stocks or the same in fixed income? Which is going to be the best performer at any given time? So we would say, right, if even though this allocation is underperforming, you should still maintain— You're still going to get the benefits of the diversification.

Andrew Patterson: It's because you just don't know. It's not that you're lacking in negative returns, you're expecting negative returns. Even if you are, again, it's that diversification because you don't know. We don't have a crystal ball. We work with portfolio construction, with economic analysis day in and day out, and we still can't predict with a great deal of precision where returns are going to be headed in a day, a month, a week, a year. Even ten years is very, very difficult.

Liz Tammaro: But these global portfolios and global recommendations, they make sense always, right? It's not based off of market conditions. We're not going to say, in a year, "Well, now we're going to change your international allocations."

Andrew Patterson: It's not a tactical move.

Liz Tammaro: That's right.

Andrew Patterson: It's a strategic move. It's a strategic approach. A lot of investors ask, "Well, why would you increase your allocation to international fixed income at this point in time when yields are low, sometimes somewhat negative depending on the region you're investing in?" Again, it wasn't a tactical call. It was a strategic call because we believe in this and the benefits of this over the long term.

Liz Tammaro: Sure.

Andrew Patterson: I think the benefits of diversification come down to what we talked about, to not knowing where returns are going to be heading, not knowing, not being able to predict those unforeseen events.

So I always go back to this example where, if you would have told me five years ago that a banking crisis in Cyprus was going to have a greater negative implication for the markets than Russia invading the Ukraine, I would have told you you were crazy. But that's exactly what happened.

So if you're trying to predict specific events that are going to impact the markets and what type of impact it's going to be, how positive, how negative, it's very, very difficult to do.

Scott Donaldson: Right, and if you focus on the past performance, so, my international securities or my U.S. securities are underperforming, that's too late; it doesn't matter. It's all about the forward-looking expectations, and nobody knows, going forward, what the performance of any asset class is going to be. So it's reducing risk, period, on a forward-looking basis as you just have to have not all your eggs in one basket is kind of the cliché.

Liz Tammaro: Makes sense. Right, so we actually have another follow-up question that just came in regarding the multinational discussion we were holding a few minutes ago. So, "Are some multinational companies' stocks traded in more than one country?"

Andrew Patterson: Oh, absolutely, absolutely. Here, in the U.S., it's ADR (American depository receipts) shares. You mentioned, I believe Nestle. So Nestle has shares listed in their home country, and then they also have ADRs that trade in the U.S. Same thing is true of U.S. companies internationally. So you can hold shares of these different stocks in different countries and, as Scott mentioned before, they tend to offset each other at times.

Even if it is GE trading here in the U.S., might perform differently than GE trading in Germany because we talked about the perceptions of those home-country investors. I'm in the U.S., I'm experiencing this downturn or this upswing, so I'm going to reflect that in my expectations for growth. I'm going to reflect that in the stock price I'm willing to trade for GE. Likewise in Germany, I'm going to reflect the current market conditions, my current economic conditions in my home country in the stock price that I'm willing to trade at.

Scott Donaldson: Yes, and you talked on, you know, the different economic environments in the different countries, and part of that is currency, right. So if you don't have exposure in some ways, on the equity side, especially, to nondollar or whatever the local currency is in a Nestle or a Samsung or a Toyota, you name the company, part of the diversification benefit in equities relative to U.S. equities is that exposure to that currency volatility.

So that's why having everything back to U.S. dollars, at least on the equity side, in at least our view, is not as advantageous to put out that cost of doing the hedging because it's not free to do. You have to hedge, but you're taking an equity risk, an equity that's already risky, and hedging away currency risk, which is a little bit of risk that's added to equity. But, in the end, you still have a very risky investment in an equity.

So hedging equity currency, at least from a U.S. investor's perspective, is not as valuable, in our opinion, as it is by taking a huge amount of risk out of a non-U.S. bond and taking that currency risk out of the equation.

Liz Tammaro: Well, and I think this is a good segue into the next couple of questions that we have around currency. So how does a strong dollar affect investing in global portfolios?

Andrew Patterson: At the end of the day, again, keeping the long time frame in mind, it really shouldn't. Investors that end up trying to chase currencies, so—

Liz Tammaro: Because this is a near-term thing?

Andrew Patterson: Exactly, exactly. Currencies, like anything else, are very, very difficult to predict with precision. So if I'm overweighting currencies in one sector and underweighting in another hoping for these things to play out, you may be right, but it may take a very, very long time for you to actually be right. So are you able to hang on with that currency bet for a very, very long time?

One of the other arguments that people make is, "Well, I believe that company X, Y, and Z—" or not even company; it's really country. So if the U.S. dollar is stronger, that means that companies in the U.S. are going to be negatively impacted. So I shouldn't hold as many U.S. securities. I should diversify globally. That's not necessarily the case because— All right, so let's use, go back to the GM example. So maybe their exports of cars are negatively impacted because of the stronger dollar because their cars are more expensive in foreign countries depending on the dynamics behind that. Are they willing to raise the price to lose market share? We don't know. We don't know.

And then you take an Apple where there's a stronger dollar and Apple is importing a lot of their components from foreign countries with weaker currencies. It's advantageous for Apple.

So to be making investment decisions based solely on currency and currency expectations alone, it's a very, very difficult process. It doesn't necessarily turn out to investors' benefits, particularly over short periods of time.

Scott Donaldson: And another thing that I think people sometimes miss is there's always this short-term noise, and, "Oh, my gosh! The dollar's going up, and my international investment values are going down as I convert back to my local currencies," or whatever the argument is, is that's on the short run. And you're going to have those types of momentum-oriented periods.

But if you think about, I think, what Andrew mentioned earlier with the way the world financial markets work, right, is if, you know, rates are high in one country, so all the dollars or all the currency flows to that company, you always have to convert back to your local currency to have it be of value to you.

And so, over the long term—rates move up, rates move down—the net effect of currency differences should wash out over longer periods of time.

Andrew Patterson: Absolutely.

Scott Donaldson: So, in theory, I think our belief is currency is a noncompensated risk. So by giving yourself the exposures to that or trying to make calls based on currency, it's a risk you're taking and, ultimately, should not expect any type of a compensation or return premium for taking on that risk.

Andrew Patterson: Sure. And currencies, in general, they tend to have a self-fulfilling mechanism within them or a self-correcting mechanism, that is. Whereas, Scott, as you mentioned, you have higher yields in country X, so you'll have a flood into that, into those bonds, into those equities, what have you. And then you have a depreciation over here, and then that benefits investors to some degree. So then their equity prices start rising, what have you, and then you'll see a flood back again. So it's a constant back and forth. So, again, trying to predict those flows with a great deal of precision, very, very difficult to do.

Liz Tammaro: And the noise that's out there, right, whether it's around a certain segment of the market underperforming or strong currencies, weak currencies, as investors and humans, right, it's hard to ignore some of that noise, but our recommendation is to try to stay the course, right—

Andrew Patterson: It's very hard.

Liz Tammaro: —and maintain a balanced, diversified portfolio and use your advisor to help you with that.

This is actually interesting timing because we've got another live question here around asset allocation. So, "My understanding of asset allocation is that once we find and accept, or once we find one that we feel comfortable with, we should stay the course with that allocation with rebalancing done within certain metrics within that allocation. Is that how you're approaching the recommendations that you have here?"

Andrew Patterson: They must have seen our previous webcasts and Google Hangouts because, absolutely. So have a lot of client discussions, and they say, "Oh, well, in the current economic environment, should I be changing my allocation in some way?"

Liz Tammaro: Sure.

Andrew Patterson: And my answer to that is always, "Has your position, has your investment horizon changed? Have you had a child? Do you have a new goal?," what have you. If that's not the case, if it's still relatively similar then, no, you should have that same asset allocation.

Liz Tammaro: Try to ignore the noise.

Andrew Patterson: Exactly. If you've had the appropriate conversations with your advisor, or even with yourself, to determine your risk/return profile, an event, even as extreme as the global financial crisis, should not change that.

Now, granted, over time, again, much like our target retirement funds do, you'll start to see you move more and more towards a more conservative allocation, more bond-heavy as you mentioned before but that's because your investment horizon is changing. That's because something has changed within your risk/return framework. Absent that, we don't believe there's any reason to think about changing your asset allocation in anticipation of a specific event.

Scott Donaldson: Well, it's interesting. The person has already asked about and brought up the concept of rebalancing. And this applies, you know, technically, to your diversification within U.S. and non-U.S. securities. I mean, if you think about rebalancing in general, it's a very difficult strategy sometimes to maintain because if you think about rebalancing is if something gets out of whack, something's doing really well, something is not doing as well and it's forcing you to sell what's doing good and move it to what's doing poorly.

Liz Tammaro: It can be hard to swallow.

Scott Donaldson: But you need to have some of those circuit breakers, so to speak, to take the emotional aspect out of it because it's very easy to get caught up in situations like Greece happening and, "What's that going to do to my portfolio, and why would I ever want to be anywhere near any of that?" But, as I mentioned, going forward, it's what's about going forward versus what's happened in the past that's very, very important. Rebalancing to whether it's stocks to bonds, U.S. to non-U.S., or what have you, keeps your strategic plan that you have set up. Theoretically, when you had no emotional attachment to anything going on is where something like a rebalancing program can really, really add value.

Liz Tammaro: Right, good. So we have a question about our recommendations, again, in non-U.S. markets. Are we recommending both established and emerging international markets, so developed countries and developing countries?

Scott Donaldson: Sure.

Andrew Patterson: Sure. So we actually take the approach of including both. So, again, there's that modicum of risk, increasing risk when you're investing in emerging market countries. Scott mentioned that before, but you're still getting that diversification benefit. That's one of the reasons why we don't advocate for investing in specific emerging market countries because you're tending to offset some of that country-specific risk by investing broadly.

But again, we think that there's benefits from a return perspective, from a risk/return profile perspective to investing in both emerging markets and developed markets as well. But again, as long as you're doing it in a broad perspective, not focusing on one specific country.

Liz Tammaro: Okay.

Scott Donaldson: Yes, and Andrew had brought up, a little earlier, this concept of a market cap weight. So you might get to the question, "All right, well what weighting of emerging markets?," which are clearly more volatile securities whether it's on the bond side or the equity side relative to domestic, not domestic, but developed country securities, for instance.

But, at a market cap weight, you're roughly looking at world market cap weight on the equity side of emerging markets that varies over time, but it's recently anywhere from 15% to 20% of the international markets, right. So we would suggest that's a reasonable allocation is somewhere around market cap weight.

On the bond side, it's much, much smaller than that, and we primarily recommend having exposure to emerging market bonds but at a market cap weight but investment-grade. Noninvestment–grade emerging market bonds are very, very volatile and basically, you know, act like equities and extremely risky. But you're looking at somewhere on the nature of 3% to 4% of the non-U.S. bond market being in investment-grade emerging market bonds.

So it's not a large percent, but, again, it's enough that it's there. It's part of the bond market and adds diversification characteristics, as Andrew mentioned.

Liz Tammaro: All right, I'm just going to take a pause here really quickly. Just a reminder to all of our viewers, I want to say, first of all, thank you for sending in these great live questions. It certainly makes our conversation very engaging. And, if you have additional questions, please be sure to continue to send them in through your computers.

So let's take a look here about foreign stocks. So we touched on this a little bit, but can you talk a little bit about the factors that impact foreign stock performance? So do foreign stocks move differently than U.S. equities, or is it more of a currency issue that's explaining the recent differences in domestic and foreign stock performance?

Andrew Patterson: So I think Scott touched on this before wherein currency does add a level of correlation.

Scott Donaldson: Impact.

Andrew Patterson: Yes, exactly, of correlation suppression, if you will. So lowering the correlation between domestic and international. That said, domestic and international securities, they've been increasing in terms of their correlation with each other for some time, whether you're talking about from a hedge perspective including currencies or, rather, excluding currencies, or unhedged, which would be including the currency risk.

So no matter how you look at it, you have been seeing increasing correlations over time. That said, our research has shown that correlations, they tend to fluctuate pretty widely over longer periods of time. So we like to call it dynamic correlation.

So I'm saying that the correlations of hedged or unhedged equities, or international equities relative to domestic equities, is higher or lower in this particular time period. It doesn't mean they're going to stay that way going forward. This comes back to the business cycle risk we talked about earlier wherein the U.S. doesn't always perform well when Germany's performing well, which doesn't always perform well when Japan's performing well. So, again, these things are all interrelated and go back to our argument for broad global diversification.

Liz Tammaro: And so the correlations are increasing, but there's still benefit, right?

Andrew Patterson: Absolutely.

Liz Tammaro: They're not perfect.

Andrew Patterson: No.

Liz Tammaro: Perfectly correlated.

Scott Donaldson: So, again, different stocks in different countries react to different things going on either locally or worldwide. But, as Andrew mentioned, you know, from a dynamic basis, which is basically that they change on a regular basis just like everything else in the financial markets, to keep that in mind. But even if correlations are, as they have been recently over the last several years, getting closer and closer to 1, which is viewed as perfect correlation. So when U.S. equities are up, international equities are up. and when U.S. equities are down, international equities are down at the same time. Correlation does not take into account the magnitude and the differences of the performance of the different markets.

Scott Donaldson: So you could have U.S. equities up 10 but international equities up the same direction but up 30. So still even if correlations if not are 1 or very close to 1, just the broad nature of being exposed to not everything in the U.S. provides a breadth of diversification. And, again, I'll always come back to the simple cliché of not having all your eggs in one basket, not knowing what to expect looking forward.

Andrew Patterson: I'd take international up 30 and domestic up 10. Seems like a reasonable portfolio.

Liz Tammaro: So let's talk a little bit about what's going on in Europe.

Scott Donaldson: Sure.

Liz Tammaro: So many people assume that Greece will collapse and will essentially leave the European Union. Are Italy and Spain far behind? And if Greece fails, what will that do to the European markets?

Andrew Patterson: So we've been having conversations about this quite a bit, both internally and with clients. Our house view really is that the likelihood of a default in Greece, it's becoming more and more of a reality. Maybe upwards of 80% in terms of probability to default. Given that default doesn't mean that they have to leave the euro zone, but odds of them doing so following that would be around 50/50. So these are difficult times, particularly in Greece. And that brings up a good point when asking about the questions of Italy and Portugal following suit.

The Greek Central Bank, in particular, I think Greek politicians in general are starting to realize that it's going to be much, much more painful for Greece to leave the euro zone than it is for the euro zone to have Greece leave. So those individuals that may fear Greece exiting the euro zone will be a blueprint for Portugal and Italy to follow suit. I don't think that's necessarily the case. It seems to me that it would actually scare them into staying or at least looking into other options before having to default, before having to go through the types of pain that Greece is going through right now.

So, yes, we are very, very concerned about Greece. We are having quite a few conversations about it. We believe that the contagion that the spreading of risks, the spreading of the volatility, it's not likely to be as great as it was maybe five years ago back in 2010, 2011.

Scott Donaldson: Yes, we've been talking about Greece defaulting for a very long time.

Andrew Patterson: Exactly, exactly. And they actually did in 2012 to a degree. It depends on your definition of default.

Liz Tammaro: Sure.

Andrew Patterson: Exactly, exactly. But the risk at that point, they were pretty well contained because central banks or banks in general had offloaded a lot of their exposure to that debt by that point, which remains true today. So you don't see the global financial system as exposed to Greek debt as it had been in the past. So the concern, really, it all comes back to the U.S. housing market and how much of an impact that had globally. The reason for that impact globally was a couple of different things, leverage included, but also that all these banks had exposure to this. And then if all these banks are in trouble, then global financial systems are significantly negatively impacted, which starts impacting financial markets, and so on and so on.

That's not necessarily the case in Greece right now. You don't have that same type of exposure to Greek debt, to the Greek government that we had in the past.

Scott Donaldson: Which kind of would lead me, if I could poll, right, all of our viewers and say, "Who's heard of a possible Greek default and Greece possibly leaving the European Union?" I'm sure most everybody would raise their hand, which gets back to the what's priced into the market already?

Andrew Patterson: Absolutely.

Liz Tammaro: Right.

Scott Donaldson: Right? So is a Greek default going to totally surprise the market?

Liz Tammaro: They've been talking about it for years.

Scott Donaldson: Banks and other countries have been reducing exposure to Greece for years and it's potentially a less impactful event. But again, as usual, anytime there's a major event like that, you always want to be aware of it but realize what might be priced into the bond markets or equity markets already surrounding that.

Andrew Patterson: And that's not to say that we're complacent by any means.

Scott Donaldson: No.

Andrew Patterson: Because I talked before about Cyprus and Russia and not understanding the potential ramifications. So not complacent by any means. I would say it's more vigilant, but we're not as nervous as some people might be.

Liz Tammaro: So, Andrew, what about quantitative easing? How will that impact European bond prices?

Andrew Patterson: So quantitative easing, right now the idea behind quantitative easing, one of the ideas behind it, is to suppress yields. People ask, "Well, if that's the case, then why have German yields actually shot up recently?," just to use them as an example.

Well the other two benefits to quantitative easing, the other two expected benefits, one would be stronger growth. So you're starting a firm growth, which, again, the actual impacts of that could be debated. The impacts on the second goal, which would be increasing inflation expectation, could also be debated but suffice it to say we saw the same type of thing happen in the U.S. where thoughts of quantitative easing, the idea of quantitative easing got closer and closer to becoming the reality and you see yields coming down, down, down, down, down. And then it's actually announced and you actually see yields rise.

Everyone says, "Well quantitative easing, it's intended to keep yields lower, but it's also intended to drive growth and drive inflation expectations higher, which are two big factors in determining yields. So I think that, at least to some degree, is what you're seeing happen in Europe right now wherein bund yields and other core-nations yields are actually increasing to some degree.

Scott Donaldson: You mean to tell me markets are forward-looking?

Andrew Patterson: Absolutely. We hope so. We hope so. Again, forward-looking without perfect foresight.

Scott Donaldson: Exactly.

Andrew Patterson: That said, you see yields in Greece that's a whole other ballgame in terms of the risk there that we talked about before.

Liz Tammaro: So we are actually almost out of time. Any final comments that you'd like to offer our viewers before we wrap up?

Andrew Patterson: Again, we've been hitting this time and again in this Google Hangout and in other Google Hangouts in the past, and I can guarantee you we'll hit it again going forward in subsequent Google Hangouts and webinars, the benefits of diversification, broad diversification. Whether you're talking about diversification within U.S. stocks, globally, what have you, over long periods of time, it serves investors well. It helps to not completely eliminate volatility, but to minimize it. And that's what we hope investors keep that perspective so they realize that maybe I won't have positive returns in any given year, but the risks of a significant downturn are mitigated by investing globally by investing in equities as well as bonds.

Scott Donaldson: Great, great summary, Andrew.

Liz Tammaro: Andrew, Scott, thank you both so much for being here tonight.

And from all of us here at Vanguard, we'd like to thank you for joining us. Please be sure to tell your advisor what you thought of tonight's event and about any future topics you'd like to see us address.

Again, than you so much for being with us and enjoy the rest of your evening.


footnote*Vanguard research—"Global fixed income: Considerations for U.S. investors", February 2014.

footnote**This is a hypothetical and does not represent any particular investment.

For more information about Vanguard funds, visit vanguard.com, or call 877-662-7447, to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Investments in Target Retirement Funds are subject to the risks of their underlying funds. The year in the Fund name refers to the approximate year (the target date) when an investor in the Fund would retire and leave the work force. The Fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in the Target Retirement Fund is not guaranteed at any time, including on or after the target date.

Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.

Investments in securities issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.

Currency hedging risk is the chance that currency hedging transactions may not perfectly offset a security's foreign currency exposures and may eliminate any chance for a security to benefit from favorable fluctuations in relevant currency exchange rates.

Past performance is not a guarantee of future results.

Advisory services are provided by Vanguard Advisors, Inc. (VAI), a registered investment advisor.

This hangout is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

© 2015 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.

Layer opened.

Is a global portfolio riskier?

Layer opened.

Is a global portfolio riskier?

Liz Tammaro: So let's go ahead and get started with our first question. So someone sent in and said to us, "Many countries overseas are not secure, and they can change quickly. Why would this investor want to take a chance like that in their investment portfolio?" Andrew, I'm going to give that one to you to start.

Andrew Patterson: Sure, thanks, Liz. So, granted, the U.S. financial markets are some of the most developed in the world; but I wouldn't say that that necessarily makes them less risky, particularly when you compare them to other developed markets. There's going to be ebbs and flows over any given time period, and many times those ebbs and flows are offset by the highs and lows of other financial markets. So your Germanys, your Frances, even getting into emerging markets. It's trying to offset those peaks and valleys with, hopefully, uncorrelated or, rather, negatively correlated financial markets. Now, what I mean by correlation, basically it's when the U.S. market is up, is this other market down? And when the U.S. market is down, is this other market that you've invested in up? So it's trying to offset that and try to balance out the volatility over time.

Liz Tammaro: Okay, so it's not so much about the security or lack thereof in these individual countries. It's about how the investments in all the countries in the world sort of balance each other out.

Andrew Patterson: It's how they interact together. So the benefits of diversification, it's really for a long-term timeframe. You're not in this for a total return perspective. You're not placing bets to increase the return in your portfolio. Again, rather to try to even out those ebbs and flows over time.

Liz Tammaro: Makes sense.

Scott Donaldson: Yeah, and it's interesting, and I think I'll add to what Andrew just said is it's actually that riskiness of some of these non-U.S. countries and that added volatility that actually adds overall to the portfolio that makes the overall portfolio less risky from a volatility standpoint. So having those countries that are more risky than others actually adds the benefit, which seems counterintuitive—

Liz Tammaro: Right.

Scott Donaldson: —but it's kind of a concept of financial and portfolio theory that adds that.

Liz Tammaro: So I'm hearing you say that an individual country that may be perceived to be risky on its own, when brought together in a broad portfolio, actually reduces risk.

Scott Donaldson: Correct. And I think if you actually look long-term at a lot of the data, you actually could see a lot of non-U.S. countries on their own have much higher volatility than the U.S. But when you add them into a portfolio, the overall portfolio volatility is actually less than each individual country and in some cases less than the overall U.S. market or very, very close to it. So it kind of points out to me that by diversifying into all these countries, less risky, more risky, adds somewhat of a diversification effect, and in some ways diversifies specific country risk.

Andrew Patterson: Absolutely.

Liz Tammaro: And so you're talking about the diversification benefit, Scott, and I want to hear your thoughts on is investing internationally or non-U.S. securities in fixed income as important as doing the same thing in equities?

Scott Donaldson: Sure, I mean, the short answer is yes. We do believe it's very, very important; and I think what's interesting is over the years, it doesn't get quite as much attention over, say, ten years ago as it does today. And part of the reason I think is the size of the market of non-U.S. bonds has evolved greatly.

It's roughly doubled, say, in the past 10 years or so as well as, 10 years ago or 15 years ago, the access to that particular market, the liquidity, the transparency of those particular non-U.S. bonds were much, much less then than they are today.* So as those costs, liquidity, and transparency have actually come down over the years and the size has grown, it's become much easier to gain access to that at a lower cost. So it's very, very important, and it adds the same type of dampening of volatility over time that investing in non-U.S. equities does adding them with U.S. equities.

Liz Tammaro: So investors are able to get access to non-U.S. bonds. It's easier today than it has been in the past, and that diversification benefit is as important there as it is for stocks.

Andrew Patterson: Absolutely.

Scott Donaldson: Absolutely, especially considering that it's now the largest financial market in the world.* So not having those bonds in your portfolio, you're excluding a very, very large opportunity set from the global financial markets.

Liz Tammaro: Non-U.S. bonds, the largest asset class.

Scott Donaldson: Yes.

Andrew Patterson: Among bonds and equities, absolutely.


footnote*Vanguard research—"Global fixed income: Considerations for U.S. investors", February 2014.

All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.

Investments in securities issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.

This hangout is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

© 2015 The Vanguard Group, Inc. All rights reserved.

Layer opened.

Vanguard's recommended international allocation

Layer opened.

Vanguard's recommended international allocation

Liz Tammaro: So let's dive into a little bit around portfolio construction here. What percentage of stocks and what percentage of bonds in a portfolio should be invested in non-U.S. markets? What do you guys think?

Andrew Patterson: So research has shown that adding any level of international bonds really helps to reduce volatility within a portfolio. Why is that? Again, as Scott mentioned before, you're aggregating all those different countries. You're aggregating all those different regions, and their bonds have different volatilities that interact, and you have the ebbs and flows counteracting each other. So you aggregate those all up whereas, if you're focused solely in the U.S. and only investing in U.S.-domiciled bonds, then you're only exposed to the ebbs and flows within the U.S. bond market.

You add those other countries in and you're starting to offset some of that risk because again, same type of concept. Over long periods of time, you're not going to see the same types of ebbs and flows in the U.S. fixed income market as you would in international markets, as you would in the Japanese market, the German market, what have you. So it tends to decrease portfolio volatility over time. So any sort of allocation there tends to add benefits.

From an equity perspective, fixed income and equity, rather, we tend to follow a market cap-proportional approach, which is what we advocate, but we understand investors aren't really comfortable doing that all the time. So much like what we did when we advocated for adding international equities, we started low. We started around 20% for fixed income. We've since moved up to around 30% for fixed income.

Equities, they've been in our portfolios. They've been in our advice for some time. Investors are becoming a little bit more comfortable with that. So we've moved, since, from 30% to 40%.

Liz Tammaro: And can I just have you elaborate on what you said around market cap is the recommendation? Can you just explain that a little bit?

Andrew Patterson: Sure. So Scott mentioned before, we talk about different markets across the world, non-U.S. dollar-denominated bonds being the largest of those. It's basically the market value. So the price times the number of shares or the number of bonds, and you get these figures, and then you look at that, and that's your market-cap proportion. So if I have a hundred shares at a thousand dollars, it's a million dollars' worth of market capitalization.

Scott Donaldson: Yeah, and I think adding to what Andrew said and if you think about, for an investor, to kind of put a range or like some guardrails around what they might think are reasonable allocations, in any case, having any international diversification, first and foremost, is the first step. But to kind of get towards a more, what we would view from a portfolio construction standpoint is market-cap weight is, as Andrew pointed out, I think, from the theoretical standpoint, would be a great place, from a forward-looking standpoint, to be at.

However, we also know that there's practical implications that investors deal with, also, on a daily basis. And one of the major practical implications these days is costs of accessing some of these markets. Going international or non-U.S. is more costly than investing in domestic securities both on the stock and the bond side. So moving closer, over time, closer to a market-cap weight certainly is reasonable. But having, as Andrew put on the equity side, at least 40% of your equity allocation and 30% of your fixed income allocation in non-U.S. securities is very important.


Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Diversification does not ensure a profit or protect against a loss.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.

Investments in securities issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.

This hangout is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

Advisory services are provided by Vanguard Advisers Inc. (VAI), a registered investment advisor.

© 2015 The Vanguard Group, Inc. All rights reserved.

Layer opened.

Does a strong dollar impact a global portfolio?

Layer opened.

Does a strong dollar impact a global portfolio?

Liz Tammaro: Well, and I think this is a good segue into the next couple of questions that we have around currency. So how does a strong dollar affect investing in global portfolios?

Andrew Patterson: At the end of the day, again, keeping the long time frame in mind, it really shouldn't. Investors that end up trying to chase currencies, so—

Liz Tammaro: Because this is a near-term thing?

Andrew Patterson: Exactly, exactly. Currencies, like anything else, are very, very difficult to predict with precision. So if I'm overweighting currencies in one sector and underweighting in another hoping for these things to play out, you may be right, but it may take a very, very long time for you to actually be right. So are you able to hang on with that currency bet for a very, very long time?

One of the other arguments that people make is, "Well, I believe that company X, Y, and Z—" or not even company; it's really country. So if the U.S. dollar is stronger, that means that companies in the U.S. are going to be negatively impacted. So I shouldn't hold as many U.S. securities. I should diversify globally. That's not necessarily the case because—All right, so let's use, go back to the GM example. So maybe their exports of cars are negatively impacted because of the stronger dollar because their cars are more expensive in foreign countries depending on the dynamics behind that. Are they willing to raise the price to lose market share? We don't know. We don't know.

And then you take an Apple where there's a stronger dollar and Apple is importing a lot of their components from foreign countries with weaker currencies. It's advantageous for Apple.

So to be making investment decisions based solely on currency and currency expectations alone, it's a very, very difficult process. It doesn't necessarily turn out to investors' benefits, particularly over short periods of time.

Scott Donaldson: And another thing that I think people sometimes miss is there's always this short-term noise, and, "Oh, my gosh! The dollar's going up, and my international investment values are going down as I convert back to my local currencies," or whatever the argument is, is that's on the short run. And you're going to have those types of momentum-oriented periods.

But if you think about, I think, what Andrew mentioned earlier with the way the world financial markets work, right, is if, you know, rates are high in one country, so all the dollars or all the currency flows to that company, you always have to convert back to your local currency to have it be of value to you.

And so, over the long term—rates move up, rates move down—the net effect of currency differences should wash out over longer periods of time.

Andrew Patterson: Absolutely.

Scott Donaldson: So, in theory, I think our belief is currency is a noncompensated risk. So by giving yourself the exposures to that or trying to make calls based on currency, it's a risk you're taking and, ultimately, should not expect any type of a compensation or return premium for taking on that risk.

Andrew Patterson: Sure. And currencies, in general, they tend to have a self-fulfilling mechanism within them or a self-correcting mechanism, that is. Whereas, Scott, as you mentioned, you have higher yields in country X, so you'll have a flood into that, into those bonds, into those equities, what have you. And then you have a depreciation over here, and then that benefits investors to some degree. So then their equity prices start rising, what have you, and then you'll see a flood back again. So it's a constant back and forth. So, again, trying to predict those flows with a great deal of precision, very, very difficult to do.

Liz Tammaro: And the noise that's out there, right, whether it's around a certain segment of the market underperforming or strong currencies, weak currencies, as investors and humans, right, it's hard to ignore some of that noise, but our recommendation is to try to stay the course, right—

Andrew Patterson: It's very hard.

Liz Tammaro: —and maintain a balanced, diversified portfolio and use your advisor to help you with that.


All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.

Investments in securities issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.

This hangout is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

Advisory services are provided by Vanguard Advisers Inc. (VAI), a registered investment advisor.

© 2015 The Vanguard Group, Inc. All rights reserved.

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Returns

The profit you get from investing money. Over time, this profit is based mainly on the amount of risk associated with the investment. So, for example, less-risky investments like certificates of deposit (CDs) or savings accounts generally earn a low rate of return, and higher-risk investments like stocks generally earn a higher rate of return.