Should you have a home bias in your portfolio in 2021?

Mr. The Poor Swiss | Updated: | Investing
Should you have a home bias in your portfolio in 2020?

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Many people use a home bias in their investing portfolio. These investors are allocating a large portion of their portfolio to domestic stocks. And this portion is not based on the size of their local stock market. But not every investor agrees on that strategy. And some people do not know what a home bias is.

So, in this article, I want to answer the question of whether investors should have a home bias in their portfolio. We are also going to look at existing research on the subject.

Home Bias in investing

So, let’s start at the beginning: what is a home bias in investing?

You have a home bias when you dedicate a large portion of your portfolio to stocks of your home country. For instance, you could say that you are allocating 25% of your portfolio to Swiss Stocks if you are living in Switzerland.

One important thing is that your home bias does not have to be in the country you are living in right now. If you are planning to retire in another country, your preference should be toward this other country. For instance, if you are living in Switzerland now but want to retire in England, you may want to have English stocks as your home bias.

In general, people should invest in a diversified way. If you believe in the efficiency of the market, you want to invest according to stock market valuations. So if your country represents 10% of the entire stock market, you should invest 10% of your portfolio in your country’s stocks.

So, if you are investing more than this 10% in your country stocks, you have a bias (sometimes called a tilt) towards this county. This country bias is your home bias.

Let’s take the example of Switzerland. Switzerland is about 3% of the world’s stock market. I allocate 20% of my portfolio to Swiss Stocks. So, I have a strong home bias towards Switzerland.

Benefits of Home Bias

There are two benefits of adding a home bias to your portfolio.

The first advantage is that if something gets bad in other parts of the world, it could reduce the volatility in your portfolio. A home country bias could greatly help you if you need the money at this time of trouble.

This first advantage also helps with currencies. If your bias is in CHF and the USD loses a lot of value, your shares in CHF will be safe from this devaluation. Again, this protection could help you in case you need to sell at the wrong time.

Research showed that a reasonable home bias (lower than 40%) could decrease volatility in local currency. If you want to retire by withdrawing your portfolio, it is essential to consider volatility.

The second advantage is that you know more about what you invest in. Investors will likely know a lot more about companies in their own countries. And investors are more likely to invest in what they know. So, if you need a home bias to start investing, then you should have one, by all means.

Home Bias hurt your diversification

Now, an investing Home Bias also has some disadvantages.

Since it is a bias, it will hurt your diversification, and potentially your returns. Now, this will highly depend on how biased you are. Diversification is critical for reducing volatility by spreading your investment over multiple countries and different kinds of companies. With a good diversification, you will have fewer risks of something happening in a country ruining your portfolio.

How much such a bias will hurt your diversification will depend on its size. For instance, if your home bias is 80% of your portfolio, you are losing on a lot of diversification. On the other hand, if it is only 20%, it may help you in times of need, and the impact on diversification may not be that high.

While diversification is excellent, it also suffers from diminishing returns. When you have 60% of foreign stocks in your portfolio, the benefits of more diversification gets lower. So going from 60% to 70% of diversification has less impact than going from 10% to 20%. Research from Vanguard confirmed these results.

Therefore, if you keep your home bias at a reasonable level, you will not pay a higher price in diversification.

Home Bias can be achieved with currencies

In practice, it is unlikely that a global event does not impact your home stocks. On the other hand, a large currency event in some countries could spare your home currency if it is strong.

So, in some cases, it does not have to be in the same country as your home bias, but it needs to be in the same currency. If you plan to retire in France, you could have a home bias with European stocks, in Euro. Of course, if you plan to retire in Switzerland, you will be limited to Swiss stocks, which are the only ones in Swiss Francs.

But, you do not have to invest in Swiss stocks to get Swiss Francs in the stock market. You could get some cash, but then it would lose value to inflation.

Something that would work instead is to have foreign stocks hedged in your local currency. With this technique, you would not lose on foreign diversification. And you would still get the benefits of having stocks protected from variations in other currencies.

Now, there are some disadvantages to currency hedging. It could be more expensive in the long-term. And no conclusive data is showing that currency hedging will yield better performance. And, currency hedging will reduce your currency diversification.

Nevertheless, using currency hedging instead of a pure home bias could be a good solution for many investors if they are more worried about currency fluctuations than local events.

Home Bias ETF may be cheaper

In some cases, an investor may save money by adding home bias ETF in his portfolio.

In some countries, it is more efficient to invest in domestic stocks than in foreign stocks. In that case, having a home bias will reduce your overall fees. And since we saw that investing fees were very important, doing so may help your overall returns.

It is not the case in every country. For instance, in Switzerland, you do not have lower taxes for Swiss Stocks than for foreign stocks. On the other hand, ETFs for Swiss Stocks generally have higher Total Expense Ratios (TERs) than foreign stocks ETFs. And the Swiss Stock Exchange itself is much more expensive than American Stock Exchanges.

But there is one thing where they will differ: currency exchange fees. When you buy a U.S. ETF, you will need dollars. If the dollar is not your base currency, you will need to buy dollars with your local currency. Foreign exchange conversions are not free. If you have a good broker like Interactive Brokers, these transactions will not be expensive. But for many other brokers,  like DEGIRO, currency conversion can be expensive. So, this adds a fee that buying Swiss Stocks will not have.

Consider the big picture

One problem with home bias is that many investors are bad at considering the entire picture.

If you have a home bias in your primary investing portfolio but have a lot of home stocks in your retirement accounts, you are likely to have too large of a bias. As we saw before, a home bias that is too large will hurt diversification. In turn, a lower diversification will reduce your returns and increase the volatility of your portfolio.

So, you should consider your entire net worth and decide how much home country bias you want int this net worth. You should not consider only your investing portfolio. It is always essential to have a good view of where you are standing and what your assets are.

For instance, in Switzerland, you should consider your second and third pillar as well. You probably have more Swiss Stocks than you think. It is always a good idea for your asset allocation to represents your total assets, not a small portion of them.

How much home bias people have?

To get an idea of what investors are doing, we can look at how much home country bias investors from different countries have in their portfolio.

I have found the results for five countries in a research paper by Vanguard.

Home Bias per Country (Source: Vanguard)
Home Bias per Country (Source: Vanguard)

As we can see, most investors have a strong bias toward domestic stocks. The most extreme example is the one from Australia, where the domestic stock market is only 2.4% of the world, and Australian investors are allocated 66.5% to domestic stocks.

In the United States, investors have an extensive bias toward domestic stocks. On the other hand, the American stock market is half of the world’s stock market. So these investors are making themselves less of a disservice than Australian investors.

In the United Kingdom, the results are better. On average, English investors have 26.3% invested in domestic stocks. So, English investors are doing a better job at diversification than most.

I also found some interesting results from Vanguard for Switzerland. Here is what Swiss investors have in their portfolio:

  • 43.79% of Swiss Stocks
  • 36.97% of European Stocks
  • 19.24% of Other Stocks

Two things are interesting in these results for Swiss investors. First, Swiss investors have a strong home country bias. They allocate more than 43% in domestic stocks. Also, Swiss investors have a second bias toward European Stocks.

Overall, Swiss investors are invested more than 80% in European and Swiss Stocks. However, these stocks only represent about 25% of the world stock market. It means that Swiss investors have an extreme European bias.

These results are fascinating. I did not think that Swiss investors had such a bias. I would not recommend such a high bias towards either Swiss or European Stocks. If you want to have both biases in your portfolio, you could do 20% in each and then keep 60% fully diversified in the world. But I prefer having only a Swiss home bias.

Conclusion

While it is a bias, I still believe that a home bias makes sense. However, it is not strictly necessary, and it should not be too large. Home bias in the range of 10-40% may help you invest and protect yourself against some foreign events. But a more considerable home bias will hurt your diversification.

I like having a home bias in my portfolio. I currently want to have at least 20% Swiss Stocks, in Swiss Francs in my portfolio. Since I consider my allocation on my entire net worth, my allocation in Swiss Stocks ETF may be lower than that. But overall, I try to stick to this 20%. I want to have such a bias in Swiss Francs to hedge against foreign currencies getting deflated.

If you do not know what to do with your home bias, I recommend adding a small home bias to your portfolio. Doing so will likely reduce the volatility of your portfolio. And it could help if you need to sell when it is the wrong time for foreign stocks.

Continue to learn more about portfolios by reading about currency hedging and whether you should use it in your portfolio.

What about you? Do you have a home bias in your portfolio?

Mr. The Poor Swiss is the author behind thepoorswiss.com. In 2017, he realized that he was falling into the trap of lifestyle inflation. He decided to cut on his expenses and increase his income. This blog is relating his story and findings. In 2019, he is saving more than 50% of his income. He made it a goal to reach Financial Independence. You can send Mr. The Poor Swiss a message here.

8 thoughts on “Should you have a home bias in your portfolio in 2021?”

  1. Hi,
    Thanks for the nice article. I have been following your blog for some time, keep up the good work!

    I’d like to share a different approach to the home bias. They way I see it, the biggest asset a person normally posesses is their potential to work. By that I mean, that the biggest part of one’s savings come by their salary, especially when you are young/far from retirement age (or even once you are already FIRE, since you can always go back and work if there is a big shortcoming). Your work is by definition very heavily biased by your home (at least pre-covid that teleworking was not very common). Therefore, I’d argue that one should have a negative bias on their investment to balance this pre-existing bias!

    I hope it makes sense, looking forward to your thoughts!

    Cheers,
    Alex

    1. Hi Alex,

      Your work is indeed a home bias. And you are paid in your local currency generally, so this offers some bias toward your local currency as well.
      Now, this is only a good bias if it is stable and if you have a job. So, this cannot replace a home bias in retirement.

      Now, if you want to negate this bias, it means you will have no bias at all. This is not what I am doing since I have a home bias in my investments. And according to your theory, I actually have two biases one for my job and one for my investments.
      Now, since the company I work for is actually a U.S. company, there is less of a bias. I can live with these biases since I plan to retire in Switzerland.

      Overall, I kind of agree that working in a country already is a bias. But I do not think we have to take this into account or negate it.

      Thanks for sharing!

  2. So if your 2p/LPP represents 20% of your total assets, does that mean you wouldn’t buy any Swiss stocks? Or would you maintain 20% Swiss stocks, and with your LPP, this would represent 40% of your total assets? Thanks!

    1. Hi Emoe,

      Good question :)

      In my case, I consider my second pillar as bonds since it returns basically nothing but is very safe. So, I do not count it towards my Swiss Stocks.
      However, I was able to invest my second pillar (i.e. if I had a vested benefits account), I would count its swiss stocks part towards my overall Swiss Stocks allocation. So, if the Swiss Stocks of my second portfolio represented 20% of my overall assets, I would not need to invest in my broker account.

      It’s indeed complicated to get a good balance when you have different investments (second, third, broker). What I would do is choose a similar portfolio in each layer:
      * Second pillar: 20% Swiss Stocks, 80% Global Stocks
      * Third pillar: 20% Swiss Stocks, 80% Global Stocks
      * Broker: 20% Swiss Stocks, 80% Global Stocks

      That would be ideal for me if I could do that. But I cannot invest my second pillar and my third pillar has more limitations on Swiss stocks.

      Thanks for stopping by!

  3. Thanks Poor Swiss, I think you make a really good point about needing to look at pension/3pillar investments when thinking about your holdings.

    You mentioned taxes, and while these are not different in CH I think they are significant in some other market. I believe in Canada taxes on dividends significantly different for domestic & foreign companies.

    The other factor, bureaucracy, my friend in Australia has to apply to trade US equities with his broker, added paper work etc… encouraging keeping it simple with domestic stocks

    thanks again

    1. Hi FrancInvesting,

      That’s completely correct, in some countries, where you invest will make some large differences in Taxes. Fortunately, here it’s not the case, even though the withholding is different, the final taxes are the same.
      In Switzerland, it’s simple to buy US equities and especially easy to buy ETFs with U.S. equities. But as you said, some countries may have more difficulty. And as such, this may encourage them to have a large home bias.
      Now, even in Switzerland, the average home bias to Swiss Stocks (44%) is too large. And many people have a large European bias (37%). Together, this is a very strong bias against diversification.
      But I do not know why this is the case in Switzerland since it’s easy to invest outside? Maybe just bad advice from banks.

      Thanks for stopping by!

  4. Another thing worth considering is where the companies you invest in do business.

    As an extreme example, I own some Phillip Morris International. They are listed on the US stock exchange but do no business at all in the US (a sister company serves the US market.)

    Thus they aren’t really a “US” business. Really you are investing in Indonesia, Middle East, Russia etc. where the company actually sells the product.

    This is especially important as we live in Switzerland, a small country. Nestle, Novartis and Roche are a huge portion of the Swiss stock market but only do 1 or 2% if their business in Switzerland. Thus, if you really want home bias you might want to invest in smaller companies.

    1. Hi Joe,

      That’s a good point. And the example of Switzerland is a good one with the three huge companies that make up most of their businesses in other countries.
      I would have to insist more on globalization in this article.

      Thanks for sharing!

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