Saturday, 19 January 2013

The Importance of Global Diversification

"Invest in seven ventures, yes, in eight; you do not know what disaster may come upon the land."
Ecclesiastes 11:2 (TNIV)
I have great respect of John Bogle, the founder of the Vanguard Group. I believe that if you are unsure how to invest your money, just do what John Bogle says. That being said, there are few issues I have with him. The first relates to his aversion to foreign (i.e. non-American) investments. According to John Bogle, if you invest in a mutual index fund that replicates the S&P500 index, given that most S&P500 companies are multinationals with operations all around the world, you are getting foreign diversification anyway.

This is wrong.

What Bogle completely ignores is the fact that, by investing in only American equities, you are limited to companies that list on a small and undiversified number of stock exchanges. Every stock exchange around the world has different listing requirements. Some stock exchanges have very strict listing requirements, demanding that companies meet demanding disclosure requirements. Other stock exchanges may have lax disclosure requirements. Furthermore, some governments or stock exchanges (or both) may be more corrupt than others. You simply don't know, and it is for these reasons that you need to diversify across stock exchanges and countries. It is not enough to invest in an index fund that replicates the S&P500. You need to invest in European shares, Asian shares, Australian shares, and so forth. And that is only looking at shares. You should invest in other asset classes as well, such as REITs, bonds, and commodities.

One good argument against diversification if it's just too difficult. For example, in my opinion it makes sense to invest in commodities like gold for the sake of diversification, but investing in gold is not simple. You can't walk into a bank and just ask for gold, and storage of the gold becomes another difficulty. However, diversifying your equity investments across different countries is easy. There are many mutual funds out there that automatically diversify across multiple countries.

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