Debating whether to invest offshore? There are pro’s and con’s, so whether you choose to or not, make the decision consciously KNOWING both.

More than 90% of the success of building wealth and investing is to do with managing emotions, so when it comes to investing it’s important to put strategies and people in place to prevent us from making big mistakes and not sticking with our plan. And we can only put those in place for things we’re aware of…

In today’s episode is a strategy that I want to make you aware of when making your investment plan. You always need to go into anything with your eyes wide open.

Show notes:

• [04.16] What is Home Bias?

• [07.35] So why is home bias a challenge to long term investing?

  • Let’s look at the pro’s...

  • So let’s look at the con’s
    

Quotes

“Depending on your circumstances, you should consider to have a minimum of 40% invested overseas if you are younger than 65.” - Lisa Linfield

“It all comes down to the fact that when it comes to investing, there’s an old saying that says you shouldn’t put your eggs in one basket… meaning that you should spread out your investments to reduce your risk.” - Lisa Linfield

“The problem is, when it comes to investing, we tend to trust what we feel familiar with.“ - Lisa Linfield

“Having investments in other countries diversifies against your currency risk.” - Lisa Linfield

“What you need to remember about Developed countries is that they are lower risk, but lower return.  Developing Countries are higher risk, and higher return.” - Lisa Linfield 

Related posts and episodes

• Investing offshore in physical property and business with Lauren Cohen

• The four foundations of investing

• Taking your investments from a park run to an iron man

• The mistake most people make when investing

• Understanding the different types of investments or assets

Subscribe to our podcast on iTunes or Spotify

Please do Subscribe to our Podcast on iTunes or Spotify and leave a review.  This helps the podcast to rank higher and therefore makes it more visible to others browsing podcasts in the hope they too may benefit from our content.

Get my book - Deep Grooves: Overcoming Patterns that Keep you Stuck

• You can get the first two chapters of my book FREE here

• If you want a paperback copy and you’re in South Africa, visit my site LisaLinfield.com

  If you want a Kindle copy or a paperback anywhere in the world, visit Amazon

TRANSCRIPT

Hello everyone and welcome to today’s episode of Working Women’s Wealth.  I’m Lisa Linfield and I’m building a community of Women who are committed to the journey of living Financially Free lives – so that we can have the money that enables us to CHOOSE – IF we want to work, where we work, and when, so that we can follow our dreams.

One of the questions I get asked often is “how much of my money should I have overseas?”.  And, when our countries go through turbulent political times, like our recent riots, or crazy presidents, that question changes to “how do I get all my money overseas NOW”.

In Behavioural Finance, or the psychology of money, there are two biases that come into play when people want to suddenly change their investment strategies in stormy seas:

1. Recency bias.  We tend to place more weight on things that have just happened, rather than a long term view…

2. Loss Aversion Bias… we feel the emotion of fear and loss, more than the impact of gains… so our animal instincts kick in to protect us – the flight, fight or fear response.  And in money, that means we want to flee.

As I always say, more than 90% of the success of building wealth and investing (and therefore my job) is to do with managing emotions.  Helping people stick to the plan.

Unfortunately we’re not good at sticking to the planned course of action that will get us the best results.  We tend to stick to our diets well when times are good and our motivation is high, but a lack of sleep or stressful time can lead us to raid the chocolate tin against our best intentions… says me who just smashed an entire bar of chocolate this afternoon.

Our investments are just the same.  A study by Putnam Retail management showed that if got scared when the market crashed, and sold your shares, and you missed just 10 days out of 15 years of being invested in shares, the 10 best days in the market, your investment would be just less than half the value than if you stuck to the plan and rode out the storm.

So whilst in investing it’s important to put strategies and people in place to prevent us from making big mistakes and not sticking with our plan – we can only put those in place for things we’re aware of.

So here’s a strategy I want to make you aware of in your investment plan.  Depending on your circumstances, you should consider have a minimum of 40% invested overseas if you are younger than 65– or in other countries besides your own.  Regardless of where you live in the world.  Yes… even if you’re in America…

So let’s start with why we don’t usually have that much overseas.

There are two major reasons

1. In South Africa, many people invest in retirement funds which restricts you to 30% investment offshore – so your country may have restrictions on overseas investments

2. Home Bias.

What is Home Bias

Home Bias refers to the tendency of investors to favour companies and unit trusts or mutual funds in their home country over those from other countries or regions.  It’s a global phenomenon – existing in both nations of high national pride and those who may be more negative.

It all comes down to the fact that when it comes to investing, there’s an age old saying that you shouldn’t put all your eggs in one basket… meaning that you should spread out your investments to reduce your risk.

If every cent you had was in only one thing – Bitcoin, a single share, a single business… you run a high risk that something will go wrong at some stage, and your money could be worth next to nothing when you need it.  When it’s flying, we think we are a genius… but what goes up, will go down.

So, the theory is you should invest in different shares, markets, currencies and geographies so that you can spread out the risk.  It’s called diversification.

So, in order to understand home bias, we need to understand the theory of how much should you have in your geography?

The answer is that it depends on which country you live in.  The principle is that if the whole world’s listed shares were the total available investment option, you should have a similar % as your country currently contributes to that.  So the American market is roughly 50% of the listed shares, so they should have 50% in America and 50% rest of the world… IN THEORY.  We’ll come to the practice later.

The problem is, when it comes to investing, we tend to trust more what we feel familiar with.  So when it comes to geography, we tend not to diversify our geographic risk. Here are some examples:

In 2018, the US made up 54% of the world’s shares by value – yet American Retail investors had 77% of their money in US Shares.  Their stock exchange performance for that year was 29th out of 45 countries in the MSCI all country index.

The Swiss, the masters of discipline, should only have 3.22% of their portfolio in Switzerland, yet on average have 44%.  The first question often asked next is, how much is in rest of Europe?  Whilst that should be 21%, they actually have 37%.... leaving them just 19% for the rest of the world, when in fact they should have 75%.

Australia represents just 2.4% of the value of the world’s shares, yet Australians in general have 66.5%.

And South Africa represents half a percent of the world’s opportunity, and South Africans have on average have more than 70% of their money invested in South Africa.

So why is home bias a challenge to long term investing?

There are pro’s and con’s of investing offshore wo whether you choose to or not, make the decision consciously KNOWING both.

Let’s look at the pro’s….

Risk to your Income stability

Here’s the challenge – if you earn your income in your home country, own a home there and all your investments are in that country, and something happens at a geographic level (devastating floods, droughts etc) or at a political level (a crazy president, or a coup) or at a local level (riots)… you could lose your job.  If however, your investments are in a different country, they may stay strong and cushion the blow, allowing you to draw money from there.

Diversifying currency risk

Having investments in other countries diversifies against your currency risk.  Every currency goes up and down.  Sometimes it has to do with what’s going on in your country and sometimes it has nothing to do with your country – and everything to do with world events.  Developed or ‘first world’ countries tend to ride in synch as a team, as do developing markets.  So if team Developed is strong, team developing tends to be weak.  Within the team though, you can perform better or worse… during Brexit the dollar outperformed the pound in the developed basket… and currently the Rand is outperforming the rest of the emerging markets…  but as a whole, you’ll ride in synch.

The economists will tell you that currencies usually lose value at the difference between inflation rates between the countries.  So theoretically, if the US has a 1% inflation and South Africa has a 5%, then the rand should weaken against the dollar by 4% (and the dollar strengthen by 4%).  However, other factors such as economic growth, interest rates etc tend to play a role.  Over time, the Rand and most emerging markets tend to lose value more than that, and so your investment value grows more.

We bought a flat in the London in 2005.  Normal growth over the last 16 years has doubled its value.  However, when we bought it, the exchange rate was R10 to the pound, and now it’s R20.  So the flat has quadrupled in value – half of which is because the rand halved in buying power.

Access to a wider range of options

This is the diversification element – that not all your money is invested in the limited shares available in your country.  Diversifying your risk means that you give yourself the chance to invest in companies all over the world that have different earnings, growth and country opportunities.

Access to industries not well represented in your country

For many countries, like the UK, South Africa and Australia, we don’t have a highly developed technology sector – so we would miss out on the growth of those industries as they go.  Similarly, if you are only investing in the US stock exchange, you would be overweight technology and underweight the elements of mining, commodities.

Australia and South Africa don’t have big biotech or pharmaceutical industries proportionately on the stock exchange – so investing offshore gets you access to different sectors.

So let’s look at the con’s

You always need to go into anything with your eyes wide open.

It’s a lot bumpier ride!

The biggest challenge with offshore investing is that it can make the value of your investments look a lot more bumpy in value.

Think back to school when we learnt wave theory.  The wave goes up and it goes down.  In investing offshore you have two waves traveling together.  The underlying value of the investments that go up and down – shares being the most bumpy – is the one wave.  But currency is the second wave.

And, as we learnt at school – when they move in synch, they can have a double whammy, and when they move opposite to each other, they can cancel it out.  So how does that play out.

Well, last year from May to around October, the waves were in synch for South Africans who invested overseas– international stock market grew significantly after the crash and the rand was weak – meaning that when you looked at your investments in Rands, you felt like Rockefeller.

Since then, the waves have been cancelling each other out – the market has continued to grow, but the rand has strengthened as the dollar weakened.  So, it just looks like the investment is flat.  If you were an American investing offshore, you would be loving life at the moment – the offshore market is growing, and the dollar has been weak.

The big challenge is when the market drops, and the currency you’re in strengthens.  Then you get a double whammy.  In your home currency when you look at the offshore value, it looks unbelievably bad.  Americans felt this way when the stock market crashed in March April last year with the coronavirus pandemic.  Not only did they have those losses, but their currency was strong so the picture looked doubly bad.

So if you’re a person who gets terrified when the value of your investments drop a lot and is likely to sell, then don’t hold too much of your investments in other currencies – OR, the way to manage against that is to ONLY look at the performance or value of your investments IN THAT CURRENCY and not your home currency.  Then you will only feel one of the waves… and not the currency one.

Personally, I tend to look at both.  When it’s a double wave upwards, I feel like a rockstar.  When it’s flat or down, then I look at the performance in the offshore currency and work out how worried I should be!  If the investment wave is up, then I’m not worried.  If the investment wave is also down, then I get a little antsy!

Ease of Access

When investing offshore it actually refers to two different things.

-          The location of the share or investment (what we’ve been speaking about all this time)

-          Where you physically by that investment from.

A share such as Microsoft may be listed in America.  You can buy that share in America, but you can also buy that share in South Africa, in the UK, or from China.

In the past, it was very difficult to access other shares or funds overseas.  These days however, you can buy almost any share or fund from almost any country.  Usually, the thing that restricts you buying it is the provider of the technology.  So your investment platform may not have what you want to invest in – in which case you may want to look at a different platform.

So when we say you shouldn’t have 100% of your investments invested in the shares of your own country, it doesn’t mean that you need to physically buy the shares in each of the countries they’re in.  You can buy them from your own country and your money never needs to leave.  I may want to buy shares on the Russian Stock Exchange – I don’t necessarily want my money there.

However, there are many good reasons to have money offshore – particularly if you have significant political risk in your own country or you have an intention to live offshore. 

For many though, they think it’s very difficult to get your money physically off shore, open up an investment account overseas, and then doing the investing.  But, it isn’t.  In most countries, the big local investment houses have a presence offshore, so they can help you move your money and open an account.

One thing you don’t want to do is to put your money in a place of more political risk.  I usually advise my clients to put it in a tax neutral, politically neutral, FINANCIALLY TRANSPARENT area such as the channel islands.  That reduces political risk.

You just need to know that, depending on the costs in your own country, investing in other countries can be more or less expensive.  So do your homework.

Information Gap

Whenever people ask me what they should invest in, I say “what you know most about” as one of the many answers.  

And this is one of the biggest reason people don’t invest overseas.  They don’t know it, or understand it enough to invest in it.  Which usually is when I say “good on you!”.  You need to upskill yourself so that you can invest with knowledge.

So let me give you some so that you can feel more comfortable doing it.

As most of you will know, I’m not a fan of choosing shares – no matter how much you think the person at the barbecue telling you about the company is a legend or not.  When it comes to offshore investing, because the options available of single companies to invest in is absolutely HUGE, you are almost never going to select the one share that’s going to perform (without inside information) – and buying a share with inside information is illegal in all countries.

So, if you’re not going to buy a share, you could buy a fund of shares – a mutual fund or unit trust or basket of shares that someone has chosen.  That someone is supported by a team of people who analyse the living daylights out of something.  They tend to be called Active Funds as they are actively managed by a human.

The other option is to buy passive funds – effectively that’s when no single share is chosen by a manager – the recipe is given.  One of the biggest providers of the recipe is a company called the MSCI – they are a research company.  So many different investment managers buy and follow the same recipe – you get the Blackrock or iShares MSCI, the SATRiX MSCI, the Vanguard MSCI – they’re all following the recipe given by the MSCI.

These days you can buy almost any recipe… let me give you some examples by geography.(for a great graphic, check out the MSCI website here)

• The MSCI ACWI is the All Country World Index – This has around 3000 shares in it from 50 countries – 23 developed and 27 developing.  If you want to buy the world, buy this one

• The MSCI World Index – is a confusing term… because, in fact, it is ONLY developed markets.  So if you live in a developing market, this is the one you should buy.

• The MSCI Emerging Market Index is what it says – All the upcoming countries.  Now, here’s what I find interesting – Greece is in this index, despite being in Europe.  It does include the usual suspects of what they call the BRICS countries (Brazil, Russia, India, China, and South Africa) but it also includes the UAE, Qatar, Poland, Taiwan and Egypt). 

• Then there are MSCI indexes for regions – such as Europe, Asia, Asia excluding China etc and for Countries.

What you need to remember about Developed countries is that they are lower risk, lower return.  Developing Countries are higher risk, higher return.  So Developing countries is way more bumpy.

For almost all the big markets, you can by an ‘excluding’ option to the above.  So you can buy the All Country World Index excluding the US, or the World or developed markets index Excluding the UK.  That’s a great way to make sure that you can get access to the other developed markets without doubling up on your home bias.

Because the universe of shares is so huge, it is difficult to get it right when talking about actively choosing the right few shares around the entire markets.  Which is why over the long term, the world index has outperformed the active managers and is consistently in the top 25% of equity funds… when as an ‘average’, it should be half way or average.

So, if you have an information gap, and you are faced with buying a share, buying an active fund, or buying an index, I’d choose an index because it spreads or diversifies your risk.  And, it’s the cheapest way to invest.

So friends, I hope that has shed some light on why and how to invest offshore.  It’s so important to do, so speak to a financial adviser for your personal investment advice.