Why you need to invest outside of Canada
There’s a lot to love about Canada: democracy, freedom, the changing seasons, musical diversity from Neil Young to the Weeknd, the chance of snow during baseball season and so much more. When it comes to investing, we also seem to love our home country, but our home country bias can put our portfolios at risk.
Home country bias means that people to have too much of their money invested in the stock market of their own country. It happens all over the world, and in Canada, it’s a particularly big problem. Canadians on average have 60% of their investments in the Canadian stock market. That’s a huge number, especially considering that Canada only makes up about 4% of the global stock market by size.
Why do Canadians have so much of their portfolios in Canadian stocks? The biggest reason is probably familiarity: we recognize the names we are investing in, they are companies we know, so we feel comfortable. Investing in a list of companies we’ve never heard of can make us feel uncomfortable, even if they are the largest names in Europe or Asia. Another reason is perceived safety: investing in a country like Canada that is a relatively wealthy country with a stable democracy feels less risky (which it is). Finally, there are tax reasons: dividends paid by Canadian companies qualify for the dividend tax credit, while dividends we get from companies outside of Canada do not get a tax break.
Is being over-invested in Canada relative to its size in the global market a problem? No. Having more than a 4% weight is fine: Canada is a stable place to invest. We’ve got a lot of blue chips companies with a history of growth, some of which pay high dividends. It’s pretty attractive.
The problem arises when we have a really big weighting in Canada, like more than 30% or 40%. There are three reasons why Canadians need to invest outside of their home country.
Canada has a lack of diversification within industries.
An economic downturn would impact both your personal financial health and your investments.
We should never rely on just one market’s performance.
Lack of diversification
Canada is a hugely diverse country when it comes to its population, but the economy? Not so diverse. Financials make up 30% of the Canadian stock market, and most of this is the banks. The second biggest sector is energy, which makes up 17% of the stock market. So almost half of the Canadian stock market is banks and energy. Diversified? Nope. When oil prices fall, the Canadian market gets hurt. Any kind of whisper of trouble in the banking sector means our market tanks. These are two big, concentrated risks.
The U.S. market isn’t very well-diversified either, with technology making up 26% of the S&P 500 and health care accounting for 14%. But when you combine the two markets, you end up with a really nicely diversified set of industries - that's because the U.S. has a lot of sectors of the economy that Canada is lacking. Similarly, the EAFE index (Europe, Asia and Far East) has good exposure to health care, industrials and consumer discretionary stocks, sectors Canada is low on. A portfolio that is invested 1/3 in Canada, 1/3 in the U.S. and 1/3 in EAFE results in a nice smattering of all the sectors of the economy.
The impact of the economy on our personal lives is real. Poor economic conditions like high unemployment, lack of wage growth, and high inflation can impact our financial health. In a weak economy, the stock market might also be struggling, which can result in a double whammy for investors: poor conditions for our personal finances coupled with falling investments. Although the stock market doesn’t always decline at the same time as a weak economy, the risk is there. Wouldn’t it be better to have some of your money invested in other countries that might be thriving while Canada is struggling?
Not betting in just one horse
Stock markets in different countries rarely have identical performance in any given year. Although they are correlated (they often all move up at the same time and down at the same time), one always does better than another. If we look at the performance of three major market indices – Canada, U.S. and EAFE – Canada was the best performer only twice over the past 10 years while the U.S. did best in 7 of those years and EAFE outperformed in 1 of those years. How one market performs relative to another has a lot to do with the particulars about what’s going on with the economy. For example, in 2022 the tech sector took it on the chin, resulting in the U.S. market declining almost 20% while Canada, with low exposure to technology, was down just 9%. In 2015, oil prices fell about 30%, dragging down Canada’s stock market, while the U.S was up slightly. Having exposure to all three of these indices could even out the performance of your portfolio.
Source: S&P Dow Jones, MSCI, Clarity
It’s easier than it’s ever been to invest in companies outside of Canada. Global mutual funds and exchange-traded funds give you instant access to hundreds or even thousands of companies outside of Canada. The fees on these funds are slightly higher, it’s true, but the high cost is well worth it, given the added diversification. Don’t be afraid of investing outside of Canada – it can do great things for you.
Photo credit: Sid Suratia, Unsplash