I do plenty of mental accounting, helps me worry less, here’s some:
I started at 2021, saw the covid drop as the first test, it was over in weeks. 2022 was annoying but ultimately ended at 0. 2023 was phenomenal. I think in what I call “compounding chunks”. 2021 was chunk A, finished with a small upside, then in 2022 became chunk B, finished at zero. 2023 is chunk C, finished at a huge upside. 2024 is chunk D and doing great so far. Within these there are subchunks, I keep track of them because I record at what price I bought. Some within chunk C have done little, others (eg 4000 CHF dropped on Oct 27th) did great.
My mental accounting tells me that loss of money for chunk C would need a drop higher than 30%, and that’s still a paper loss unless I sell. Anyone who’s stayed with the US for 4+ years will practically never lose their principal, unless the US becomes a communist country.
Similar vein, I hadn’t bothered to look at VXUS, now I did and was dismayed: 17% in 13 years? Shocking. It basically cannot ever catch up with VTI, it’s mathematically impossible at this point. That’s a ton of compounding, effort and discipline put down the toilet to satisfy academics and theorists. Sticking with all-world market cap weight.
It doesn’t need to become communist to descend into civil war or default on its debt.
Edit: …or war with China - though that may actually be good for stock prices.
What may not be so good for U.S. stock prices: China cutting off their separatist province of Taiwan and prevent them from bypassing export restrictions, taxes etc. on their illicit sale of semiconductor products to the world market,
So you only invested once at let it ride? Or else your description doesnt make sense.
In reality you invest new money all the time and what happens in the future is completely open and cannot be deduced from the past.
How can 1$ I invest TODAY in VXUS never catch up with a dollar I invest today in VTI? They are at the same starting point. The dollar I invest today doesnt care a single bit on what the dollar I invested 10 years ago did.
btw those 17% in 13 years are only price and ignore dividends paid. The total return with dividends reinvested is around 100%, still not great, but not as terrible as it seems.
Edit for clarity: It has to do with how I think in the chunks I described above. It’s mental accounting at it’s worst, I realise that! What I mean is that whatever happened in the past is “let to ride” in my mind. In that sense money plugged into the US market in 2023 has torn away from money plugged in ex-US in the same year, with little chance of it ever being in the red: 20% gains (in USD) in 2023, plus nearly 6% gains YTD would need >25% drop to even go back to zero, let alone make a paper loss, let alone make a real loss if I panic sell. That makes me feel pretty good for my past decisions. It’s all emotional and mental accounting, as I said I am new into this!
Of course a CHF invested today has some chance to of doing well in either VXUS or VTI, but some chunks, tranches, years, whatever you want to call them, invested in ex-US will really never catch up, so that’s an opportunity cost. Anyway, the discussion is not amazingly productive, (but still more productive than in the Boglehead subreddit) some are concerned about US valuations, some aren’t. In any case, as I wrote in the bottom of the dip thread, I am pooling some money at the moment because I am getting fearful - if it continues to go as it does, great, going even deeper in the green, if it doesn’t I still feel fine knowing some (old) gains are nearly locked in.
What is so “wow” about this? That’s exactly how stock markets work, you can’t predict the future based on past performance, because a very high part ofvit is human behaviour and humans are irrational.
In our recent history the largest drops were ~50-55% (depending on what index you’re looking at, VTI or VOO), twice, over ~2.5 years (2000-2002, 2007-2009), ~25% over about a year (2021-2022). Funnily enough the 1987 crash left the S&P500 with a tiny gain from year open to year close.
NASDAQ100 had indeed a 81% drop in 2000, but shrugged off the 2007-2009 drop due to not including financial companies.
The 1929 crash lead to a 90% drop over 3 years but my understanding is that policy was put in place to safeguard this from happening again.
While a 50% drop in VTI is possible, a 80% drop in one’s portfolio is unthinkable in my opinion unless we’re talking leveraged ETFs, crypto, crazy gambling with naked options/shorts etc. And of course, we should be buying on the way down as well as on the way up as many of these drops are not sudden but sustained over 1-3 years.
I suppose the point is not to focus on individual chunks.
Some of them will lag, some will outperform.
What really matters is the long term growth of your entire portfolio.
But I agree, Value had a bad hit (in comparison to Growth) the last 10+ years.
History shows though that this is to be expected. At least based on the past, the factor(s) overperform.
Psychologically of course everything matters . That’s why even the most ‘fanatic’ of factor investing they Tilt and not go 100%!
This suggests lower expected returns for someone investing in the whole world, market cap weighted.
Is this a valid argument to overweight non-US stocks?
(by e.g. buying VTI + VXUS and overweight VXUS).
In theory the total market portfolio (e.g. VT) maximizes returns and minimizes variance. So, messing with manual weights will create something suboptimal.
What is a sensible manner to come up with manual weights for VXUS and VTI, otherwise?
Bonus: VTI + VXUS seems cheaper and more complete than VT.
Based on capital market projections: the expected returns of US stocks will be lower than international for next 10 years. Many firms try to do this projection. One of those studies is at link here. Similar studies can be found at JP Morgan, black rock etc.
The challenge is that these are just predictions. No one actually knows what would happen. There is a chance that US continues to outperform and hence valuations in US are justified. On other hand, there is a chance that predictions come true.
So, if you really believe in this theory (and are willing to accept lower returns if the theory doesn’t hold true) , then VTI / VXUS could be a good option. Otherwise accept the market average returns whatever they are (VT)
What about the efficient market hypothesis?
Everybody knows about these forecasts,
so prices should already be “fair” and therefore,
the market portfolio should already be optimal.
I think the US market is still extremely undervalued. It outperformed the other markets for decades and keeps doing so. While the US produces amazing new companies the best Europe come up with in the last decade was Wirecard.
For that reason I‘m 70% into US (10% of it being 3x leveraged).
The efficient market hypothesis applies to the participants as a conglomerate but each of them is in there with different circumstances and for different reasons.
While I am currently searching for a single ETF with broad diversification and low US exposure for the very reason you have stated (high valuations), I find it difficult to do so because part of the high valuation of US stocks can objectively be justified by:
low dividends → favorable tax treatment (doubly so for Swiss investors).
favorable tax treaties with other countries (doubly so for Swiss investors).
On a personal level, I’m still willing to take a hit from these advantages and reduce my allocation to US stocks, though not by as much as I would if it was just a valuation/expected future returns question with all else being equal.
You are right.
Efficient Market hypothesis suggests that every stock is rightly priced with all available info and hence consistent alpha generation is not easily possible.
What you are trying to do is to generate alpha. Hence your suggestion would be that Europe is undervalued versus what market is pricing it to be.
Same goes for people who are overweighting US, they are also trying to generate alpha.
I think very few people are actually 100% VT which is true global market exposure across caps.
My personal situation is that I am automatically underweight US because of my Home Bias allocation to CH and IN. So for me nothing needs to change.
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. That’s why even the most ‘fanatic’ of factor investing they Tilt and not go 100%!