Investing guru Warren Buffett once said: “In the business world, the rearview mirror is much clearer than the windshield.”
What he meant was, seeing the road ahead can be very challenging, particularly when investing your wealth. While you may see forecasts or tips from so-called experts, the truth is, nobody can predict the future.
That’s why investing always involves some level of risk. Fortunately, you may be able to manage that risk by adopting a balanced strategy. It may be particularly beneficial to diversify your investments and spread your wealth out. That way, if certain investments fall in value, you may be able to cover those losses with gains from elsewhere.
Yet, many investors fail to achieve this diversification because they suffer from “home bias” – a tendency to concentrate investments in local assets.
Of course, it’s important to consider your own goals and attitude to risk when investing. You might decide that sticking to the UK markets is the most suitable option for you and there is nothing inherently wrong with this. That said, you may be taking on more risk or passing up on the opportunity for greater growth by doing so.
Read on to learn more about home bias and how looking further afield could help you diversify your investments.
Investing 25% of your wealth in UK markets could be considered “home bias”
If an investor suffers from home bias, it simply means that they concentrate a disproportionately large share of their investments in local assets.
For instance, according to Barclays, the UK stock market makes up around 4% of the global market. Yet, you might place far more than 4% of your investments in UK assets. If this is the case, you may have a problem with home bias.
In this instance, figures reported by Barclays define home bias as investing 25% of your portfolio or more in UK markets.
As such, you don’t need to put your entire investment portfolio in a single market to be negatively affected by home bias, and it may be more of an issue than you realise.
Familiarity is comfortable for investors
There are several reasons that investors might be attracted to local assets. For many people, the familiarity of home markets is comfortable.
You recognise and understand the companies in UK markets, and this may make you feel more in control of your investments. As a result, you might perceive the risk differently and feel that it’s “safer” to invest in familiar local markets.
Additionally, some investors let past experiences colour their perception of overseas assets. If you have experienced losses on foreign investments before, you might decide that investing further afield always carries a greater risk.
While it is natural to feel more comfortable with the familiar, taking this approach to investing could increase your risk and reduce opportunities for growth.
Luckily, by removing the home bias, you may be able to protect your wealth and encourage more growth in the future.
3 potential benefits of looking further afield when investing
1. Avoiding unintended concentration risk
Concentration risk occurs when a small number of stocks have a disproportionate effect on the overall performance of the market.
The US stock market is a prime example of this. According to Barclays, the US stock market makes up 58% of the entire global market share. As such, you may think that concentrating investments in the US should create a relatively well-diversified portfolio.
However, the performance of the US stock market is largely driven by seven major tech companies. In fact, the Guardian reports that the “Super Seven” as they are known, make up 17.2% of the entire global market.
That is the same as the entire stock markets of Japan, the UK, China, France, and Canada combined.
Concentrating your investments in the US may be beneficial right now as these tech companies have experienced rapid growth in recent years. However, if the tech industry experiences a period of volatility, you could see significant losses because a large percentage of your investments are concentrated in one sector.
While the “Super Seven” is an unprecedented example, it does demonstrate the potential for unintended concentration risk if you focus a large percentage of your investments on a single market.
By investing in various markets around the globe, where companies in different sectors drive market fluctuations, you may be able to shield yourself from this.
2. Reducing the effects of political and social factors
Numerous political and social factors can affect global markets and cause the value of your investments to rise and fall.
For example, in September 2022, Liz Truss and chancellor Kwasi Kwarteng delivered their controversial mini-budget, which shook faith in the UK markets. As a result, the value of sterling fell to historic lows and borrowing costs skyrocketed.
If your investments were primarily focused on the UK market, you may have felt the effects of this event very acutely. Conversely, if your investments were well diversified, potential gains from investments in other geographical regions could have helped to offset losses and balanced your portfolio.
3. Creating more opportunities for growth
Investing in one specific region could mean that you miss opportunities to invest in growing economies or lucrative sectors.
For example, the UK market is dominated by the service sector, with only a small percentage of businesses in agriculture or industry. China, on the other hand, is more equally weighted, with a much higher percentage of businesses in the industry sector.
By investing in different global markets, you can ensure that your wealth is spread across various sectors, and reduce the risk of missing opportunities for growth.
More importantly, certain economies perform better or worse at different times, for a myriad of reasons. Currently, there are several emerging markets that are experiencing significant growth, such as India, for example.
If you stick to local markets and ignore these shifts in the global economy, you could miss out on a chance to benefit from investing in growing markets overseas.
Get in touch
If you are concerned about home bias in your investment portfolio, we can help you expand your reach.
Please get in touch to find out how our team of VouchedFor Top Rated planners could help today.
Please note
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.