Do plan participants invest with one arm tied behind their backs? It’s a reasonable conclusion when you consider that about 91% of defined contribution plan assets are limited to U.S. investments, according to PSCA’s 59th Annual Survey of Profit Sharing and 401(k) Plans, 2016.
Such an approach misses out on the majority of the world’s investment opportunities:
Imagine what it would be like to keep 80% of the products in a store off-limits? But that’s what DC plan participants are doing by confining their retirement portfolios to the U.S.
Investing internationally, on the other hand, allows participants to share in the long-term growth potential of some of the world’s most dynamic companies. On the Forbes 2016 list of the world’s largest 2,000 companies, 1,460 – or 73% – are domiciled outside of the U.S.
Economists have long observed that investors in all countries tend to avoid foreign markets, an inclination they call “home bias.” What continues to puzzle investment experts is why it happens. Investing outside of one’s home country is great way to increase opportunity and reduce the risk of too much exposure to the domestic economy. Yet people who think nothing of buying a foreign-made phone or car still struggle with making a rational decision when it comes to foreign investing.
“There is still no way to reconcile portfolio theory with the size, pervasiveness and persistence of the equity home bias,” reports The Equity Home Bias Puzzle: A Survey, a recent academic paper by Cooper, Sercu and Vanpee.
Fortunately, there’s a solution for plan sponsors tasked with ensuring adequate diversification among their retirement plan participants.
U.S.-only investments in plan lineups can easily be converted into comparable global ones that incorporate both U.S. and non-U.S. investment securities.
A core lineup of three to five broad-based global funds would also lend itself to menu simplification, a great way to improve participant engagement.
Investment managers make the allocation decisions rather than participants. Managers can dynamically reallocate among non-U.S. and U.S. strategies to seek to take advantage of global trends. Participants, on the other hand, rarely revisit their initial allocation decisions.
A global strategy is easier to understand than solely non-U.S. options introduced to participants as “international.” The term “global” tells participants that their “risky” non-U.S. allocation will be combined with U.S. investments, reducing the discomfort of investing in markets they perceive as too risky or unfamiliar.
Geographical flexibility allows active managers to invest in the best companies regardless of where they are headquartered. Where a company is domiciled has become less relevant in a globalized economy where component parts can be sourced anywhere and the economic footprint for a company can spread worldwide.
Although retirement plan menus are adding international funds, participants have yet to increase their exposure to non-U.S. assets. That’s why the simple step of merging U.S. and non-U.S. options into a combined global menu is crucial. This new global menu may ensure that the investment portfolios of plan participants are as wide-ranging as their buying choices.
Investing outside the United States involves risks, such as currency fluctuations, periods of illiquidity and price volatility, as more fully described in the prospectus. These risks may be heightened in connection with investments in developing countries.
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the mutual fund prospectuses and summary prospectuses, which can be obtained from a financial professional, and should be read carefully before investing. Similar information about collective investment trusts can be obtained from Capital Group or participants' plan provider or employer.
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