The Problem Of Home Bias And How To Avoid It

Posted by John Adam on May 21
toa-heftiba-95456-unsplash

A majority of investors show signs of a pattern dubbed ‘home bias’. It means they tend to only or mainly invest in assets based in their own countries. For investors from the UK, home bias would mean mainly investing in UK-based stocks and bonds. Or funds that also focus on domestic assets. The 2018 Charles Schwab ‘Home Bias Report’ surveyed 200 UK investors with at least £25,000 in investments. It found that 74% showed home bias.

With the London Stock Exchange making up just around 6% of global stock markets, home bias is putting a lot of eggs in one basket. U.S. stock markets account for 54% of the world stock market, Europe minus the UK 19%, Japan 8% and ‘emerging markets’, which includes potentially faster growing countries and regions such as China, India, Central & South America, large parts of Asia, Africa etc., 13%.

A well-diversified stock market investment portfolio that gives the holder a better chance of returns that reflect global economic growth over the long term would invest across different regions. It boils down to the same reason why it can be more risky to invest all your money in just a few stocks, one fund or one sector. In the shorter term different investments will perform better than others so a good mix smooths out volatility. And in the longer term you protect yourself from things not going to plan in one particular country or region by spreading the risk across the world.

Economists are pretty confident the world as a whole will continue to get wealthier as poorer countries get richer. It’s a lot harder to be sure about the long term prospects of any particular country or region.

The Home Bias Report found the main reason behind the home bias phenomenon is little more than the psychological comfort of the familiar. Which is also probably why recent data from online investment platforms Interactive Investor and Hargreaves Lansdown shows the big tech stocks such as Amazon, Apple and Tesla are the most popular non-UK options among their account holders. They are brands that Brits are very familiar with.  

But only 7% of investors surveyed as part of the Charles Schwab report said they were generally interested in allocating capital to U.S. stocks. That’s despite the fact that the U.S. market offers greater exposure to the whole global stock market compared to London and that the S&P 500 has performed far better than UK benchmark FTSE 100 in recent years. Home bias is by no means a phenomenon unique to UK investors but appears to be especially pronounced. And it’s influencing investors’ long term returns.

The Potential Benefits of International Investment Exposure

The global economy ebbs and flows and the different international regions don’t all perfectly correlate at any given moment in time. Over the last few years the U.S. economy has been doing well and that has reflected in its stock market’s performance. At other times China, Asia or other parts of the world have seen stronger growth. The London Stock Exchange’s moment to deliver better returns than Wall Street will also probably come again.

In 2017, emerging markets returned 37.8% but in 2018 were one of the worst performers as a group. There is no obvious or reliable pattern to the rotation of the best performing regions so concentrating investment in one or trying to ‘time the market’ makes little sense.

And even if the biggest companies already have international exposure because much of their revenues are earned abroad, their share price performance is still influenced by general local sentiment. Which is why the share prices of the FTSE 100 companies have done less well than those of the S&P 500 over the past couple of years despite their financial results often not obviously justifying the difference in valuations. 

Diversifying a portfolio internationally can help smooth out the ups and downs of particular regions. It also avoids a concentrated bet, which might not come off, that any particular market will outperform others over the long term. As a modern investor, the world really is your oyster. There’s no good reason not to make the most of that.

Written by John Adam

John has almost 10 years of experience as a writer and editor on consumer finance and investment topics. An entrepreneur, he has one successful exit behind him and currently writes and consults freelance while enthusiastically pursuing hobbies he's not very good at such as football, squash and raising a small child.

Ready to see how your money could grow?

a month

Build a free example investment portfolio with no commitment.