October 17, 2020
Most readers know that I added an international index fund to our personal investment portfolio.
Ever since then, I’ve been meaning to write this post. Because let me tell you, there’s no shortage of options to choose from!
Too much choice often leads to overwhelm, which is really unhelpful when it comes to investing. So today, we’ll browse the menu and take a look at some of the most common options for investing overseas.
From there, we’ll look under the hood and see what’s inside. Which funds make sense? What are the pros and cons of each? And how should we decide what to invest in? Lots to discuss, so let’s dive in.
(Friendly disclaimer: These comparisons are for informational purposes only. Please do your own research when making financial decisions.)
The first step is to get clear about why we’re investing overseas. People will have different motivations and goals when it comes to choosing an international index fund to invest in.
Are we investing overseas for some extra diversification? Do we want exposure to every global market, or just one country in particular? Are we happy to have multiple funds or do we want just one? Do we want the absolute lowest fees, or do we want the fund we think will perform best?
As you can see, there are many factors at play. I’ll offer my thoughts on different options and explain why I chose the fund that I did. (beware, the official fund names are a mouthful!) 😉
Developed markets make up most of the world’s equity markets (around 85-90%), with emerging markets making up the other 10-15%. In a minute you’ll see exactly which countries this includes.
So let’s focus on the most common index funds for investing in developed markets. The following two options give you an overwhelming amount of global diversification with just one fund.
What does VGS invest in? Vanguard’s VGS is an index fund which seeks to track the return of the MSCI world index, excluding Australia.
In plain English, VGS invests in over 1,500 medium and large companies from developed countries all over the world. Here’s VGS broken down by country…
And in case you’re interested, here is the breakdown of the top 10 holdings and sectors…
What’s not included? VGS does not include small companies. Nor does it invest in any emerging markets. Medium and large companies from developed markets only.
Management expense ratio (MER): VGS has a management fee of 0.18% per annum. That’s pretty cheap for how many companies it gives you exposure to.
Pros: VGS is a widely diversified index fund. Being domiciled in Australia, it’s simple and transparent. Because of this, there are no confusing tax issues (more on this below). By that I mean Vanguard goes out and buys shares of the underlying companies for you. Other index providers do it differently (more on this soon).
Cons: Other international index funds are cheaper. And if you want emerging markets or small companies, you’ll have to invest in other funds for that.
What does IWLD invest in? IWLD is an international index fund like VGS. It invests across developed markets around the world, with a few key differences.
IWLD also includes small global companies as well as Australia (at around 2% of the fund). So in this sense, it is a total market fund covering all developed countries. As you can see below, IWLD has roughly the same spread of countries as VGS…
What’s not included? IWLD does not include emerging markets.
Management expense ratio (MER): IWLD has a very low management fee of 0.09% per annum. Half the price of VGS. But there’s a catch: IWLD does not go out and buy the shares for you to replicate the index.
Instead, it buys its US domiciled funds to create the same thing (using a handful of ETFs). This keeps cost down, but creates some tax issues. Multiple funds also seem to create more turnover when the fund is rebalanced.
Pros: The management fee is very low. Small companies are included. Also, the fund is domiciled in Australia so there are no estate tax issues which can be the case when owning US domiciled funds (more on this here).
Cons: Because the fund is not as large as VGS ($125 million versus $2.2 billion), the spread when you buy and sell is also quite large (the difference between the market price and the price you can buy). So although the management fee is half the cost of VGS, you’re losing that benefit to other inefficiencies. (see more detail in a comparison between VGS and IWLD here)
Because the US has the majority of the world’s major companies, some see the US as the only worthwhile place to invest outside Australia.
For that reason, many folks go for a simple US-only index fund like the following three options.
What does VTS invest in? VTS is a fund which tracks the total US stock market. There are around 3,500 US companies of all sizes in VTS at the time of writing. I won’t bore you with the names of big American companies as you already know them!
What’s not included: The fund is US-only, so it holds nothing listed in other markets.
Management expense ratio (MER): The management fee of VTS is mind-blowingly cheap at 0.03% per annum.
Pros: You get exposure to the entire US market, with small caps included at an incredibly low fee.
Cons: This fund is domiciled in the US, which means there are potential tax consequences down the line in terms of estate tax as mentioned earlier. And a form you’ll have to fill out every three years.
What does IVV invest in? As you might guess, this index fund invests in S&P 500 – the largest 500 stocks in the US.
What’s not included: IVV does not include small companies as it is only the top 500. Nor does it include anything outside the US.
Management expense ratio (MER): The management fee of IVV is very low at just 0.04% per annum.
Pros: IVV is ultra cheap and holds the biggest blue chip American companies, many of which are global. It’s also domiciled in Australia so there are no tricky tax laws or forms to worry about.
Cons: Smaller companies are ignored. And some would say this excludes too much of the world’s other equity markets.
What does NDQ invest in? This ETF invests in the biggest 100 non-financial companies listed on the NASDAQ stock exchange. Therefore, the number of companies in NDQ is much smaller than the above options. This makes it much less diversified. Take a look…
Holy cow! Half the fund is in tech stocks, with 25% in just two companies! This concentration has been the winning hand in recent times, but it’s unlikely to stay that way forever. It makes the Aussie market look like the epitome of diversification! 😉
What’s not included: NDQ doesn’t really include medium or small sized companies. And obviously, nothing outside the US.
Management expense ratio (MER): The management fee for NDQ is much higher than the other options listed here, at 0.48% per annum. Fans would suggest the higher fee is worth it.
Pros: If you think tech is going to eat the world and these companies are going to keep growing, then maybe NDQ is what you want. But history would tell us to be cautious of that assumption – quite often, today’s darlings end up being tomorrow’s disappointments, especially when they’re trading at expensive valuations.
Cons: Relatively high fees. Plus, NDQ is a very concentrated bet. If large tech companies run into trouble, or fall out of favour, this fund will be hit hard.
Outside developed countries like the US, UK, Japan, Australia and so on, there are lots of less mature markets to invest in.
Emerging countries account for a big chunk of the world’s economy, but only a small slice of global markets (see below).
Therefore, some say we should invest in these up-and-coming countries as they’ll grow to become bigger pieces of the pie over time. But that may or may not occur. Don’t assume that high growth economies lead to high returning stockmarkets. That’s actually not the case (see here and here).
Emerging countries have less stringent reporting standards, rule of law and transparency than we do. There’s likely to be less scrutiny over the way shareholder’s capital is managed.
And finally, corruption can be more common and governments are less predictable, making the investing environment more costly and less certain.
What does VGE invest in? VGE invests in an index of around 5,000 companies listed in over a dozen emerging markets. The fund is heavily weighted to China, followed by Taiwan, India and Brazil.
What’s not included: Developed markets are not included.
Management expense ratio (MER): The fee for VGE is currently 0.48% per annum. Much higher than broad international index funds like developed markets. But this should reduce as the fund gets bigger.
Pros: Access to companies from all over the emerging markets, many of which are dominant in their local countries. China has impressive tech giants of their own, just like the US. Maybe they compete and one day overtake the US giants, who knows?
Cons: Less stringent rules and investor protections than we have in Western countries. Fees are higher. And emerging markets can be less stable, politically and economically, with their markets being more volatile. Some see the volatility as a positive, whereas other investors won’t.
What does VAE invest in? VAE is an Asia-only index fund, which excludes Japan. So you could think of it like ’emerging Asia’. Like VGE it’s top allocations are China and Taiwan. But unlike VGE, VAE has decent exposure to Korea and Hong Kong. It holds about 1,300 companies compared to roughly 5,000 for VGE.
What’s not included: Other emerging markets like Latin America and the Middle East. And developed markets.
Management expense ratio (MER): The management fee is 0.40% per annum, so a little cheaper than VGE.
Pros: If you want to take a long term bet on Asia, this is the way to do it. You may also prefer the breakdown of countries compared to VGE.
Cons: Higher fees than a developed markets index. Plus, with VAE, you’re really taking a bet on a region which may or may not turn out in your favour.
What does VEU invest in? VEU invests in everything outside the US, including emerging markets and small companies. VEU holds almost 3,500 stocks from the following countries…
What’s not included: The US, hence the name!
Management expense ratio: VEU has a tasty low management fee of 0.09% per annum.
Pros: A great way to compliment a US fund like VTS (see above). Combining VTS/VEU gives you the entire world market, including emerging markets and small companies. It could also serve as an alternative international index fund for those who think the US market is too expensive.
Cons: VEU is domiciled in the US, so it comes with tax issues like VTS as mentioned earlier.
Enough of this glancing around. Here are the most common combos for international index funds for investors who want to get global exposure…
One developed market fund and one emerging market. This would be VGS or IWLD for developed, and VGE or VAE for emerging. For those who include emerging markets, a common allocation is about 5-15% of their total portfolio.
An alternative is to go with VTS and VEU for a combined and complete global exposure. With the US being about 50-60% of the global market, and VEU making up the other 40-50%, it’s a pretty neat combo. The problem is the tax issues mentioned, which are not ideal, nor are they easy to understand!
Unfortunately, investing internationally is not quite as simple or cheap as it is for our friends in the US!
What we really need is a Total World ex-Australia index, that is also domiciled here so there’s no tricky tax concerns. The fund would own everything outside Australia – just like VTS and VEU in one fund.
Then all an investor has to do is decide how much they want to invest in international shares.
Hopefully one day an index provider will create this fund to make things nice and simple. Either that, or maybe Vanguard will convert VTS and VEU into Aussie based funds – that would be good enough.
I did actually email Vanguard about this a while back, but they informed me they are working on other things. It’ll be interesting to see how this space evolves over the next 5-10 years.
Okay, this one isn’t strictly an international fund. It’s more like an all-in-one fund which is heavily invested in international shares.
The veterans will know this option, of course it’s…
What does VDHG invest in? This fund holds a portfolio of ETFs. Together, they form a globally diversified portfolio, which includes Aussie, international, emerging market and small cap shares.
VDHG has 90% allocated to ‘growth’ assets, and 10% allocated to so-called ‘income’ assets, like fixed interest and bonds. Here’s the full breakdown…
What’s not included: …nothing as far as I know. Everything’s there in one fund.
Management expense ratio (MER): The fee for VDHG is 0.27% per annum. On the surface, that may sound expensive compared to other options here. And it is, but..
Pros: The simplicity of an all-in-one fund is pretty neat. For those who don’t want to decide where to invest, rebalance, or just take a 100% hands-off approach, VDHG is a solid option. Outsourcing the decision-making could be a mental and practical benefit worth paying for.
Cons: VDHG holds multiple ETFs and rebalances to stay within its target range of exposure for each holding. This means it buys/sells each year to maintain the same weightings, making it less tax efficient than doing it yourself.
Ideally, you’d simply add money to the holding that is underweight and no selling is needed. It’s roughly the same in retirement, when it’d be better to sell the best recent performer from your portfolio to get some cash.
Betashares has released a similar fund in the last 12 months – Betashares Diversified High Growth ETF – using their own ETFs and some from other providers. Not covered here (post is already too long) but I think it’s also a great option!
From all these options, I’m investing in VGS. The reason is, it offers fairly broad exposure with one fund at low cost, to sit snugly alongside our Aussie shares.
The goal wasn’t maximum possible diversification. Instead, I see diversification as insurance against the off chance that Australia does poorly over the next few decades. And I don’t need to own every stock from every country in the world to do that.
Why no emerging markets? Simply because I choose to invest heavily in Australia, and we have strong ties with emerging countries due to our resources, immigration and so on. Because of this, I think VGS compliments our portfolio more, and I don’t feel the need for emerging markets.
But I won’t try to avoid emerging markets specifically. So if they were part of a broader international index (or VTS/VEU) that’d be fine. And while I’m open to another option coming along, I consider VGS good enough for my purposes right now 🙂
There are plenty of other combinations and options that we could point out, but these are probably the most noteworthy.
I’m often asked about my thoughts on other types of funds, which are usually more exciting and exotic. These are always higher cost, higher turnover, less diversified and less easy to understand! Not only that, but they’re often a specific bet on a sector, strategy or theme.
Call me boring, but I tend to not bother looking at many options these days. I’ll just stick with broadly diversified index funds, and buy-and-hold style LICs.
More often than not, people look at what’s done well for the last 10 years and look to double down on it. What comes to mind here is US tech stocks and anything growth related. And who can blame them? Look at these returns…
Date: September 2010 to September 2020.
US market: 17.3% per annum.
AUS market: 7.9% per annum.
Wow! This has led many people to believe the US will outperform forever. But before we get carried away, let’s remember that start and end dates play a huge role. Here’s what happened during the previous 10 years…
Date: September 2000 to September 2010.
US market: -5.9% per annum.
AUS market: 7.8% per annum.
Yes, that’s a minus! An even bigger contrast! The US was unfortunate to experience two large crashes during that time period (tech crash and GFC), whereas Australia only really had one (GFC). Now let’s look at both periods together.
Date: September 2000 to September 2020.
US market return: 5.0% per annum.
AUS market return: 7.6% per annum.
(figures from the Vanguard interactive index chart)
What does this prove? Well, nothing really. But it tells us that looking at certain start and end dates can have an impact on our view of the world and affect our decisions.
Things like this have tended to even out over the long term, with both countries doing better at different times and both having similar long term returns after inflation since 1900. Granted, the US has outperformed overall since 1970.
Either way, it’s probably best to avoid assuming that one factor, region or strategy will keep on winning. This has been written about countless times by people much smarter than me.
We’ve come full circle now. We’ve looked at the main options and now it’s up to you to decide.
Clearly, my favourites are those which offer a balance of solid diversification, simplicity and low cost. But there isn’t a ‘best’ option!
Which option sounds like a good fit for your situation? Do you want maximum diversification? Or do you consider one international index fund good enough? Do emerging markets make you nervous? Or do you think they have great potential?
A quick word on fees: while fees matter to our investment returns, I wouldn’t simply go for the cheapest option here. That’s because fees for all these funds will likely keep falling over time, as they have since the beginning of index funds over 40 years ago.
There’s a psychological aspect to consider too. If you invest in markets that you genuinely believe are going to do well long term, it will be MUCH easier to stay the course during a nasty downturn.
But if you invest in something you’re less convinced of (maybe because you see other people own it), you can easily talk yourself into selling if that fund underperforms for a long time.
At the end of the day, it really comes down to how you want to invest. Maybe you only want to own Aussie and US shares. Maybe you want to copy the breakdown of the entire global market. Or maybe you just want the simplest option of all, in which case you might go with a ready-made fund like VDHG.
Whatever you do, just keep it simple. Pick something you’re comfortable with and get started. As most people do, you’ll probably adjust your plan over time, so there’s no need to stress and feel like it’s a ‘forever’ decision.
What if I had to suggest something to get started with international investing? Pick a broad global fund (covering most international markets), or a US fund at a minimum (the biggest market) and go from there.
If you feel it makes sense to diversify more than that, then by all means go for it. But adding one of these gives you most of the benefits of diversification with just one fund.
I hope this article has helped you compare the most common international index funds. We covered a range of sensible low cost diversified options for long term investors.
It’s clear to me there’s no right answer, except what suits you and your personal circumstances. Don’t get me wrong, making sensible investments is important. But I think the FIRE crowd tend to over-analyze and nitpick the investment world to death.
We spend too much time worrying about the unknowable future and thinking about all sorts of risks. We forget that we’re already on the extreme end in terms of financial security, personal adaptability, and the diversification of our wealth and income streams.
Whichever path you take, I wish you all the best. And remember, the input (your savings rate) is more powerful than the output (your investment returns), especially when it comes to retiring early.
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