Should European investors invest in the US stock market?

You live in Europe, don’t earn in USD and don’t spend in USD. Should you have significant investments in funds with American holdings? Should you bear the currency risk associated with having assets in a different currency?

You are highly invested in US stocks whenever you invest in a S&P 500 index fund (100% US stocks), in a MSCI World index fund (~53% US stocks) or in a FTSE All World index fund (~54% US stocks).

Equity is an extremely volatile asset class. Stocks can quickly loose or gain a significant percentage of its value. According to the Credit Suisse’s Global Investment Returns Yearbook 2018:

  • During the post-WWII recovery (1949-59), real equity returns of Germany equity was 4373%
  • During the nineties tech boom real equity returns of German equity was 154%

Currency-pairs do not fluctuate like this! While currency pairs do have some volatility, its impact on returns of equity is minimal when compared to the inherent volatility of stocks. Currency risk only really matters for bonds because that asset class has low volatility.

Therefore, your main criteria to invest in certain geographic markets should be their returns.

The US’s stock market accounts for 51% of total world value and has had the best equity real returns if we consider the 1900-2017 period (6.5% annualized). For this reason, US equities are a reasonable choice.

The hard part about choosing the market with the most returns is that we can’t predict the future. We only have data from the past. And we know that in some periods some countries perform worst, in other periods other countries perform better:

  • During the nineties tech boom Japan’s real equity returns were -42% while USA’s real equity returns were 276%
  • During the Wall Street Crash in 1929-31 Japan’s real equity returns were 11% while USA’s real equity returns were -61%

Therefore, choosing a global tracker index fund where each country is weighted according to their market capitalization allows us to diversify the risks while allowing us to capture a good return. According to the Global Investment Returns Yearbook 2018, such a global portfolio would have lead to 5.2% in annualized real returns. Those returns are 20% lower than the best performing market, USA, returns over the same period. But you didn’t incur the risk in choosing the wrong market to invest into.

In essence, the argument for a global index fund is similar as the argument for a broad-market index fund (like the S&P 500 or STOXX 600). Buy a low-cost fund which holds the whole market (includes but not limited to the US), get exposed to the whole market’s risk and to the whole market’s returns. Average market returns with above average performance (outperforming 80% of the investors) with minimal costs – that sounds like a great deal to me.