The chart
here,
provided by Dimensional Fund Advisors, is one of the most telling and
fascinating we have seen on the subject of world market capitalization
(including both developed and emerging markets). It displays the concept
visually, both geographically and by relative size.
Of the
approximately $40 trillion in world market capitalization at the time of
the chart’s creation (12/31/05), the U.S. holds $15.7 trillion, almost
40% of the total. Obviously this means that international markets hold
the other 60% and long ago surpassed the size of domestic markets. To
put that in perspective, in 1970, the U.S. markets held about 2/3 of
world market capitalization. For individuals wanting to mirror the
market, this would direct such investors to maintain international
holdings that would make up more than half of a portfolio.
Consider also the
ratio of developed countries to emerging markets. Developed countries
make up 88% of world market capitalization. Emerging markets account for
the other 12%, which is comparable to just over triple the market share
of Microsoft, General Electric and Mobil Oil combined.
While we hear much
about it on the news as it works to develop its market system, China’s
market capitalization at this time was comparable to that of Microsoft.
(To see it visually, compare China’s square on the chart with the
dashed-line square in the corner of the United States.) Perhaps this
should dampen the fervor with which some investors are rushing into
China funds.
So given this
information, should individual investors mirror the world capitalization
exactly? If we take a closer look at the chart, we see that the
unshaded area totals about $2 trillion. These are markets that we are
not comfortable investing in at this time. Once those are eliminated, we
get closer to a 50/50 mix, which is actually a suitable ratio. However,
it is worth noting that studies show individual investors all over the
world are much more comfortable investing in companies domiciled within
their own borders (Americans like American companies, Germans like
German companies, etc.). Given this predisposition, we recommend at
least 30% of one’s portfolio invested in international markets -
including emerging market asset classes. Then perhaps over time the
amount can be increased. This strategy provides substantial and
meaningful exposure to the economies overseas that often will outperform
U.S. markets. We just don’t know when. The answer, of course, is to
maintain a close relationship with the investor’s best friend:
super-diversification.
