Slice and dice international

From Bogleheads

As an alternative to investing in a foreign total market fund, it is possible to slice and dice international allocations by holding separate regional funds: emerging markets plus either a developed markets fund or separate pacific rim and european funds.

Characteristics of slice and dice

The primary advantage of a total market fund is simplicity: a single fund whose market weights are maintained automatically. A secondary benefit for a Vanguard investor is the potential inclusion of Canadian stocks, which represent about 6% of Vanguard Total International Index Fund.

Possible advantages/disadvantages of slicing and dicing internationally revolve around costs, taxes, and diversification.

Expense ratio comparison

Expense ratios (FY 2012)
Fund ETF Investor Admiral Purchase fee
(mutual fund)
Redemption fee
(mutual fund)
Vanguard Total International Index Fund 0.16% 0.22% 0.16% n/a n/a
Vanguard FTSE All-World ex-US Index Fund 0.18% 0.35% 0.18% n/a n/a
Vanguard Tax-Managed International Fundd 0.12% n/a 0.12% n/a n/a
Vanguard European Stock Index Fund 0.14% 0.26% 0.14% n/a n/a
Vanguard Pacific Stock Index Fund 0.14% 0.26% 0.14% n/a n/a
Vanguard Emerging Markets Stock Index Fund 0.20% 0.33% 0.20% n/a n/a
† ETF shares have commissions, spreads, and discount/premium costs on purchase and sale.

The relative cost advantage of using ETF or investor/admiral shares is dependent on many factors, including size and frequency of the investment, expected holding period, the level of commission and trading costs, and realized return. To determine the relative costs between an ETF and a mutual fund, you can use Vanguard's cost comparison calculator.

Taxes

  • Foreign tax credit. With the transition of Vanguard Total International Stock Index Fund and Vanguard Developed Markets Index Fund from fund of funds to funds now directly holding stocks, all Vanguard international funds fully qualify for the foreign tax credit.
  • Tax loss harvesting. Slicing and dicing the international allocation may give rise to more tax loss harvesting opportunities because the components (Europe, pacific, and emerging markets) do not necessarily move in the same directions.
  • Qualified dividend. Qualified dividends, which are subject to a maximum 20% tax rate (15% for tax year 2012), were realized over the past five years at the percentage rates indicated in the following table. Only the tax-managed international approach appears likely to attain a sustainable realized qualified dividends advantage.
Qualifying dividends (investor shares)
Fund 2007 2008 2009 2010 2011
Vanguard Total International Index Fund 78.74% 69.75% 70.19% 70.74% 78.44%
Vanguard FTSE All-World ex-US Index Fund 87.23% 73.82% 76.55% 71.16% 72.98%
Vanguard European Stock Index Fund 82.29% 76.32% 82.46% 71.66% 78.29%
Vanguard Pacific Stock Index Fund 60.58% 100.00% 77.49% 81.25% 82.24%
Vanguard Emerging Markets Stock Index Fund 59.93% 64.33% 61.38% 55.54% 62.01%
Vanguard Tax-Managed International Fund 100.00% 100.00% 100.00% 100.00% 100.00%
Vanguard Developed Markets Index Fund n/a 78.80% 69.51% 71.78% 77.31%

Diversification of currencies

According to Rick Ferri in All About Asset Allocation, having fixed allocations between Europe, pacific, and emerging market diversifies currencies better than one fund.

Possible rebalancing bonus

Also according to Rick Ferri, rebalancing of those currencies "could provide a diversification benefit, as it has in the past". William Bernstein suggests a rebalancing bonus may be obtainable with emerging markets (see External links below). Note that rebalancing in a taxable account may lead to payment of capital gains taxes.

Overweighting pacific or emerging markets

Historically Europe has been more correlated with the U.S. market than pacific and emerging markets, so you may want to overweight pacific or emerging markets. The market weight as of January 31, 2010 was approximately 50.1% Europe, 26.2% pacific and 23.7% emerging market according to the allocation of the Vanguard Total International Stock Index Fund, which follows the market capitalization.

Avoiding regional bubbles

Total market funds will change as the underlying market weights change. With Japan as an example, maintaining a fixed weight to Japan/pacific in the 1980's might have avoided an overallocation to Japan. More recently, in 2010 emerging markets increased to 23% of the world market (according to composition of Vanguard Total International Market fund, January 2010), from about 4% in 1998.[1]

See also

References

  1. John Bogle (1999). Common Sense on Mutual Funds. ISBN 978-0-471-39228-6.

External links