Very confused about domestic/international stock allocation

[catacomb]

Hello,

I live in Israel which has a strong economy but quite a small one.

I read the new PP book and according to chapters 6 and 12 investors are encouraged to buy domestic stocks for their stock allocation and limit exposure to international stocks to 5%-10% at most.

That is, unless one lives in a very small country (followed by the examples of Belgium and Singapore), where investors should diversify to nearby economies (EU or Pacific zones respectively). What should the Israeli investor do?

I might be missing something but this overly domestic approach of the PP might not be suitable for investors living in smaller countries.  I reckon it is dangerous to allocate 20% to the Tel Aviv-25 ETF (tracking  25 large-cap Israeli companies).

As it is my PP is heavily biased domestically in a way that I feel harms the concept of diversification: my cash and bonds portions are both already in the form of Israeli government debt. I buy, earn and invest my IRA and pension funds in Israeli currency. 

So I'm looking for alternatives to Israeli stocks for my 25% stock allocation.

Please assist.

[KevinW]

I agree with the advice in the book, which is that investors in countries with "large" economies should only invest in their domestic stock market, and investors in "small" economies should invest in a broader umbrella index that is relevant to their home country. We don't have a crisp operational definition of "large" or "small." Consensus seems to be that Canada (PPP GDP $1,445 billion) is large. A while ago I looked into the Czech Republic ($287 billion) and decided it was small. Israel is about the same size ($237 billion) so I'm inclined to say it's small. (I don't actually think GDP is a good metric for this, I just used it as a ballpark metric of economy size.)

If you agree Israel counts as a small economy, you have to decide which broader stock index to invest in. In the case of Czech R. it was fairly clear the answer was the Eurozone. I have to admit that I'm ignorant about the current state of Israel's day to day trade partners. Is the economy intertwined with your local neighbors? If so a Middle East index might be appropriate. Or is your biggest trade partner the USA? Or some other big economy?

[Thomas Hoog]

Nice question
I'm afraid that a Middle East index (if exist) is mostly a oil based index, which will be not very diversed.
Why no be very practical and just take a World stock index (DM+EM) maybe in your own currency, otherwise dollars.
I really don't know if the world index is contrair to Israel Bonds, but the alternatieves, a USA index or a Europa index, has the same problem.
I would even buy some LT USA Bonds, to reduce dependency on your own goverment.

[frugal]

Hello,

I'm in a small country and I have NO domestic assets.

What about and worldwide stock ETF ?

How do you manage currency risk?

Regards

[Thomas Hoog]

You are from Portugal, that's still Europa, so you can buy the Europa Stocks (in EUR)
Isreal is definitly no Europa Country with their own currency (Shekel ??)

[k9]

I don't understand that geographical bias in the PP.

That's called market timing : it is precisely the same as saying "I think industrial stocks will far outperform other stocks, so I invest 90% in industrial stocks, 10% in other stocks" or "I think small caps will far outperform big caps, they always do on the long run" or "I think stocks will far outperform other asset classes". There, US PPers are saying "I think US economy will far outperform other economies". One of the PP's motto is : do not try to outsmart the market, buy it as a whole. That means : buy a worldwide index, and consider any local ETF as a part of your VP, not your PP.

Making a difference between foreign and domestic really feels anti-PP to me. Or maybe I didn't get it.

[MediumTex]

For an Israeli PP investor I would lean toward a world equity index, with perhaps 20-30% of the stock allocation in an Israeli equity index (if there is such a thing) if you are a big believer in your home country's economy.

In general, the PP is a bet on different economic conditions.  By investing in home country sovereign debt, you are making your inflation/deflation prosperity/recession bet at the level of your home country.  Thus, it makes sense to link your equity investment to your sovereign debt investment (i.e., tie them to the same economy), assuming that the economy you are talking about is large enough to avoid the risks associated with small and/or one industry economies.

For the U.S. investor, it's simple.  For PP investors in other parts of the world, it's a bit more complicated.

[LazyInvestor]

I think HB's observation about USD being a world reserve currency is critical. He mentioned they run to gold only when there's some crisis or loss of confidence in USD. As such, I don't think it's very unlikely that we could have extreme prosperity in US pushing down the value of gold, and at the same time a government of a small country going insane with their printing press and causing hyperinflation.  In such cases, having USD is even better than having gold, and that's what most in small/corrupt/developing/unstable countries do - they diversify out of their currency into USD. It doesn't take too much to realize that having the US PP is maybe even better than having just USD for an individual in such a country/situation.

In a such country I'd rather go with a pure Bogleheads portfolio such as three fund portfolio with domestic bonds  than with a pure domestic PP. Or maybe I would have a combination of a Bogleheads portfolio and US PP, maybe 50-50.

[Gosso]

In a such country I'd rather go with a pure Bogleheads portfolio such as three fund portfolio with domestic bonds  than with a pure domestic PP. Or maybe I would have a combination of a Bogleheads portfolio and US PP, maybe 50-50.

That's basically what I did.  I took the standard Canadian Global Couch Potato Portfolio and added gold to it.  It has performed and behaved very similarly to the US PP.

http://canadiancouchpotato.com/model-portfolios/

Obviously I had to increase the bonds to 50% and drop the stock weighting to accommodate the gold.

[Thomas Hoog]

I think I agree with K9
There is not such a thing like equity investment in your domestic country.
I could buy the AEX index (Netherlands), but the componies have almost nothing to do with the local economic situation. 80 % of their revenues are global. BMW sells more cars in China then in Germany and for APPLE USA is just a small nice market.

[catacomb]

Thank you all very much for your answers.

I should have mentioned that as an OECD country Israel is included in the MSCI EAFE index, which could be a good idea to track.

Here's my Israel-oriented PP, I would love to get some feedback on it:

Stocks:

15% -  Vanguard MSCI EAFE ETF - VEA (USD)
5% - Vanguard Total Stock Market  - VTSMX (USD)
5% - Domestic Israeli Index Fund tracking the Tel Aviv-100 index  ( New Israel Sheqel)

Gold:
25% - ZGLD.US (USD)

Long Term Bonds:
15% - Government of Israel, January 2042 (New Israeli Sheqel)
10% - TLT (USD)

Cash:
15% - Israeli T-Bills (New Israeli Sheqel)
10% - SHY (USD)


What do you think ? Is it smart to "mix" different currencies within the same portfolio? Should I perhaps manage a USD portfolio and an Israeli currency portfolio separately?

Thank you again

[LazyInvestor]

It looks nice to me. I'd put VTSMX to 10% and VEA to 10%, and then you have a nice 40% US PP and 60% Israeli PP, which I would keep separate and let them go whichever direction they want (rebalance only within a portfolio), while adding in new money in 40-60 proportion. I think it's a good choice for the gold ETF. Once I checked some gold 1oz Israeli coins sold by Israeli mint, but they were selling them at 20% above the spot price, so a big ripoff (they look awesome tho)...

[frugal]

@catacomb
catacomb

which broker will you use that has VTSMX?

Regards.

[KevinW]

Looks reasonable to me, with LazyInvestor's tweak to the stock allocation. I think the currency exposure should be the same across all asset classes.

[catacomb]

@Frugal: Sorry, I meant to say VTI, and I use a local Israeli broker.

@KevinW: Could you explain what you mean by " the currency exposure should be the same across all asset classes." Do you mean that the same currency ratio should be kept throughout? for example, 60% USD, 40% Sheqel?

[KevinW]

Yes, that's what I mean. IMO the currency mixture needs to be the same for stocks, bonds, and cash. Ideally they are all 100% the same currency, which is why I think a USD PP should use only US stocks. If one is going to mix currencies, which seems reasonable in your case, it should be the same mixture for all 3 assets. I.e. 60/40 USD/Sheqel for stocks, bonds, and cash. Otherwise you introduce a peculiar tilt to the portfolio.

[catacomb]

Alright, thanks for clearing this up for me. I was confused after reading that bonds and cash should be held in domestic currency.

What about gold? I have the option to buy an Israeli gold ETF which tracks the price of gold set in the london AM fix. It is denominated in Sheqels.

Should I for example buy 15% of that ETF and 10% of a dollar denominated gold ETF?

(BTW Buying physical gold in Israel is not easy and importing it makes you pay a 17% VAT stamp...)

[Pointedstick]

Alright, thanks for clearing this up for me. I was confused after reading that bonds and cash should be held in domestic currency.

What about gold? I have the option to buy an Israeli gold ETF which tracks the price of gold set in the london AM fix. It is denominated in Sheqels.

Should I for example buy 15% of that ETF and 10% of a dollar denominated gold ETF?

(BTW Buying physical gold in Israel is not easy and importing it makes you pay a 17% VAT stamp...)

If holding physical bullion locally is too much of a hassle, what about using Perth Mint or BullionVault? I'd say using either for a portion of your gold allocation will be significantly safer than an all-ETF approach.

It might be worth the hassle to acquire some physical bullion, though. And besides, that Jerusalem of Gold coin is absolutely gorgeous!

[frugal]

Pointedstick Pointedstick Pointedstick

Do you know how much % per year we pay at Perth Mint  ?

As I  know is too much!

[KevinW]

If holding physical bullion locally is too much of a hassle, what about using Perth Mint or BullionVault? I'd say using either for a portion of your gold allocation will be significantly safer than an all-ETF approach.

+1

You might also consider the other offshore holding arrangements described in the PP book. Swiss bank accounts may be available to Israeli citizens unlike US citizens.  I don't know very much about the legal and tax details of gold ownership in Israel.

[AdamA]

Pointedstick Pointedstick Pointedstick

Do you know how much % per year we pay at Perth Mint  ?

As I  know is too much!

It depends on how you hold it at the Perth Mint.  Unallocated charges no storage fee. 

[frugal]

Pointedstick Pointedstick Pointedstick

Do you know how much % per year we pay at Perth Mint  ?

As I  know is too much!

It depends on how you hold it at the Perth Mint.  Unallocated charges no storage fee.

AdamA AdamA AdamA

can you please explain what we can have with low costs?

Tks

[escafandro]

Investors in countries with "large" economies should only invest in their domestic stock market, and investors in "small" economies should invest in a broader umbrella index that is relevant to their home country.

This is easy to do with the stock portion.
But what to do with the bonds and cash?