Disclosure: This article is for informative purposes only and should not be considered as investment or tax advice.
In my work as a financial consultant I see home and/or geographic bias far too often. What is geographic or home bias you ask? My favourite site for a quick refresher in investment terminology, Investopedia defines it as:
“…the tendency for investors to invest in a large amount of domestic equities, despite the purported benefits of diversifying into foreign equities. This bias is believed to have arisen as a result of the extra difficulties associated with investing in foreign equities, such as legal restrictions and additional transaction costs.”
Now, in English. If an investor exhibits home bias than their portfolio, or investment basket, would be too focused on their home country. This term could be expanded to geographic bias, meaning an investment portfolio is too focused on any one country, regardless of whether it is their home.
So, why is focusing investments in one country bad? After all, Canada is a huge country, surely it must have a diverse economy?
There are several reasons having too many eggs in one basket is a bad idea. Continuing with Canada as our example, let’s look at my home country’s GDP by sector for the period of Aug. 2016 to Aug. 2017.
Here’s the two most troubling aspects:
10.3% of CAD GDP is from mining, quarrying, and oil and gas extraction. Cyclical (read volatile) industries if ever there was one. This stat alone is increasingly worrisome after today’s news of Norway’s sovereign fund massively divesting from oil.
5.9% of CAD GDP is from finance, insurance, real estate. The so-called FIRE economy is a pillar of most Western economies, and is usually relatively stable. However, one only has to look to the Lehman Brother’s incident of 2008 and its ensuing impact on global stock markets to see that this sector is not immune to chaos.
Clearly a shift in either of these two sectors would greatly impact a Canadian focused investment portfolio. Combined they make up nearly 1/6 of Canada’s GDP. I don’t know about you, but I certainly wouldn’t be comfortable knowing that an oil-price shift could have a lasting impact on my retirement plans.
How about the US though? The following figures are based on the 2016 calendar year.
Again, the two most concerning figures:
18.4% of US GDP is from manufacturing. Now this sector certainly doesn’t follow the cyclical nature of mining/oil production, but 18.4%!? That’s nearly a fifth of the economy. While it is extremely unlikely that manufacturing as an industry would disappear all of a sudden, let’s not forget that it was only 9 years ago (2008) that the auto-industry was devastated.
17.3% of US GDP is from the aforementioned FIRE economy industry. Again, banks, insurance companies, and real estate are relatively stable industries, but when they crash, they crash hard and bring the market with them.
Some quick math shows that 1/3 of America’s GDP stems from just two sectors. Again, not comforting to think that a new trade deal, or financial disruption (ie: continued increased acceptance of crypto-currencies) could impact such a huge portion of a US focused portfolio.
To summarize, Canada’s top two sectors combine for 16% of it’s GDP, while America’s top two sectors combine for a whopping 36% of it’s GDP, with the FIRE economy making up a significant portion of both countries GDP. Here’s an article discussing the importance of geographically diversifying your investment portfolio and also examining Canada’s market makeup.
In short, geographical diversification is an important step in protecting your investments from volatility. The sector-risk associated with a non-geographically diverse portfolio is often overlooked by investors, but hopefully this brief article and accompanying links highlights its importance.
Ciao for now!