How to Avoid Home Country Bias in Your Investment Portfolio

Canada is the second largest country in the world, but the Canadian stock market represents only about 3% of the world’s market capitalization. 

Yes, we’re tremendously patriotic.  We also tend to steer towards what we know – the businesses we work for and the companies we buy from.  But that lack of diversification can stunt portfolio growth.

Home Country Bias

Home country bias is when investors overweight domestic stocks in their portfolio compared to the global markets.  It’s true in most countries, but it’s more troubling in Canada because our stock market is highly concentrated in the financial, telecom and energy sectors.

To diversify your portfolio you need international exposure as well.  The U.S. stock market makes up approximately 50% of total market capitalization, and while there are no guarantees, the performance of the U.S. economy and stocks as a whole have been strong. 

Many large U.S. corporations are multinational and have worldwide enterprises so they also benefit from growth overseas.

Global index weight reflected by country’s weight in the MSCI World index as of May 31, 2019

Individual stocks or ETFs?

You can of course buy individual U.S. stocks in a variety of sectors that are just not available in Canada such as industrials, health care, consumer staples, materials and biotech.  But instead of buying U.S. stocks, get full diversification from an Exchange Traded Fund (ETF) with a low Management Expense Ratio (MER) that tracks the S&P 500.

Even successful investor Warren Buffet has recommended investors buy index funds instead of trying to pick individual stocks.

For my non-Canadian exposure I have taken his advice to heart.

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There are a variety of ETFs that have MERs of less than .1% and many have achieved double digit returns over the last five years.

Since they simply track the S&P index, these funds all hold the same giant companies – Apple, Microsoft, Amazon, Berkshire Hathaway, JP Morgan Chase, Johnson & Johnson, Exxon Mobile and Alphabet (Google).

Buying in U.S. funds

Hold your U.S. dollar investments in your RRSP or RRIF to take advantage of the withholding tax exemption on dividends. 

One important note:  the U.S. withholding tax exemption applies only if you hold a stock or ETF traded on a U.S. exchange.  If they are in a Canadian fund you will pay the 15% tax even in an RRSP/RRIF.

Here are some of the largest U.S. index-tracking funds to consider:

  • Vanguard S&P 500 ETF (VOO/NYSE)
  • iShares Core S&P 500 ETF (IVV/NYSE)

Investors who don’t want to overweight in the relatively new Internet names (or are still reeling from the bubble) can find ETFs that focus on more well-established dividend paying giants such as Intell, Verizon, Home Depot, WalMart and PepsiCo.

Check out these funds:

  • Vanguard Dividend Appreciation ETF (VIG/NYSE)
  • Vanguard High Dividend Yield ETF (VYM/NYSE)

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Canadians with taxable accounts may prefer the TSX listed equivalents of the above funds, such as:

  • Vanguard S&P 500 ETF (VFV/TSX)
  • iShares Core S&P 500 ETF (XUS/TSX)

Canadian dollar hedging

There’s no getting around the fact that buying investments in U.S dollars faces currency risk and those variations will have a big effect on investment returns.

One way to protect yourself is with Canadian-dollar hedged ETFs.  These tend to be a bit more expensive but the returns have been not much lower than their non-hedged equivalents.

Many advisors claim you shouldn’t bother with hedging as currency fluctuations will even out in the long run.  Also, if you spend a lot of time in the United States – and have a U.S. dollar account – you might not ever have to reconvert back to Canadian dollars.

However, if you spend your time in Canada, you might as well hedge because Canadian currency is what you will be using.

The bottom line

The Canadian stock market is a small part of the world markets – only about 3%.  U.S. markets are many times larger and also contains global exposure with multinational companies.

A broad based U.S. market index investment with low fees is a good choice to get your diversification and avoid home country bias.

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