Where is the Money? looks at how equity capital is allocated within the United States and around the globe. This update is based on data as of May 2014.
When it comes to investing, familiarity often breeds confidence. People invest in what they know (or at least what think they know).
Folks who work in the technology industry often buy tech stocks, like Apple or Google.
The same is true in the aerospace and defense sector, as I often hear employees of Boeing or Northrop ask me what I think about stocks of other A&D firms (e.g. Raytheon, Honeywell, Lockheed, etc.).
Some employees buy stocks in their industry because they think they have an information “edge.” Others do it simply because they “know the company” or work next to the building.
Likewise, most American investors own portfolios that are dominated by U.S. companies, while having a tiny (or nonexistent) allocation to international stocks. This is what is known as “home bias.”
In light of this, I always try to remind investors that both the U.S. and international stock markets are huge. Almost incomprehensibly so.
As of this writing, the world market cap of exchange-listed publicly traded companies was over $42 trillion!
Yet, most investors spend their time talking about and investing in just a handful of stocks or industries.
Breakdown of the World Market Cap by Asset Class
| Market | Total Value | Global Weight |
|---|---|---|
| United States | $21.02 trillion | 49.81% |
| Foreign Developed Markets | $16.84 trillion | 39.91% |
| Foreign Emerging Markets | $4.34 trillion | 10.28% |
| Total | $42.2 trillion | 100.00% |
As you can see in the above chart, even as big as the U.S. stock market is, it represents less than half of the value of the world market cap.
Thus, most investors are significantly underweighted in their allocation to international developed and emerging market stocks.
Although a true “market portfolio” would essentially replicate the global weightings in this table, even a 30% allocation to international stocks would be a strong step in the right direction for the average investor.
U.S. Industry/Sector Allocation
I am generally not a fan of sector investing, particularly all of the new sector ETFs that are flooding the market, and I don’t advise investors to waste their time with them.
However, I do think it is instructive to review how the U.S. stock market breaks down in terms of industry weighting.
As the pie chart illustrates, the U.S. economy is rather diverse. No single industry makes up more than 19% of the stock market’s total value.
In addition, energy, industrials, consumer discretionary, health care, and financials all command between 10% and 14% of the market.
Thus any portfolio that invests exclusively in a single industry is not only extremely risky, but missing out on the vast majority of the domestic investment opportunity set.
Interesting Facts You Probably Didn’t Realize
- Apple (AAPL), with a market cap of roughly $555 billion, is more valuable than the aggregate market cap of Spain ($531 billion). In fact, there are 33 developed or emerging market countries shown on the map above whose total market cap is dwarfed by Apple.
- Although more than 20 countries are classified as emerging markets, their combined market cap is still just one fifth of the value of the U.S. market
- Depending on which index you look at there are roughly 3,500 to 4,000 public, exchange-listed companies in the United States. Internationally, there are another 6,000 to 10,000 companies.
- If you include frontier market countries, pink sheets, and grey market stocks, there may be as many as 45,000 to 50,000 publicly-held companies
- Even the largest industry in the United States, information technology, still makes up less than 20% of the total U.S. stock market
- If your entire portfolio consisted of energy stocks, you’d be missing out on roughly 90% of the U.S. market
What All of this Means for Investors
Avoid home bias – More than 50% of the aggregate value of the world’s stock market is outside of the United States. If the stocks in your portfolio are dominated by U.S. companies, you should reconsider your asset allocation.
Diversification is the only free lunch – Restricting your portfolio to certain countries or sectors introduces a whole host of unnecessary risks. This is particularly true if you work in a given industry and your portfolio is dominated by stocks in the same sector. Think about a scenario where you lose your job as a result of an industry downturn. Not only are you out of work, but your portfolio will have likely taken a significant decline as well.
Ignore the pundits and talking heads – A lot of so-called investing gurus think they know which sector or country is poised for high returns. The reality is that no one can know for certain what the future looks like. Industry or country bets are just that. Bets. Are you really willing to risk your future on a guess?
Source: Dimensional Fund Advisors, Global Market Breakdown, May 2014. The Russell 3000E Index is used as the proxy for the US market. The proxies for the non-US developed and emerging markets are the respective developed country and emerging country portions from the MSCI All Country World IMI ex USA Index.
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[…] People tend to invest in things that are familiar. But the U.S. stock market only represents 50% of the global market. A rational investor should want to participate in the gains the whole capital […]