How to get a globally diversified portfolio with just one ETF
Make this your first equity ETF pick
Most investors face the same dilemma at the beginning: information overload! There are thousands of funds to choose from, an internet’s worth of investing wisdom to digest, so much seems to ride on making the right decisions… it’s no wonder analysis paralysis afflicts most first-timers.
But there’s a simple hack that cuts through the problem: it’s called a World Index ETF.
A World Index ETF is an equity tracker that spreads its holdings across the major investable countries of the world.
Investing theory and experience tells us that the vast majority of people should:
- Invest in equities to achieve long-term growth
- Diversify as widely as possible to reduce risk
- Choose simple, low cost investing products
- Avoid trying to beat the market
A good World Index ETF hits all these bases. If you choose one that follows a reputable index like the MSCI World then you are instantly invested in the leading companies of the world’s developed economies.
Just one low-fee product gives you exposure to the US, the UK, Japan, Western Europe, Australia, Canada and more – 23 advanced economies in total.
That’s a smart move because you’re not tied to the fortunes of any single economy. By investing in the world, you avoid excessive exposure to Brexit, lost decades in Japan or any other adverse economic scenario that can befall a country.
Invest in the world
A World Index ETF means you don’t have to make complicated decisions about how to allocate your funds. Instead, you piggyback on the wisdom of the crowd. Microsoft and Apple are the biggest companies in the world because of the aggregate decisions of the global investment community to invest more of its wealth in those two than in any other firms.
By investing in a World Index ETF you are acknowledging a simple truth: that the best answer to the question “Where should I put my money” is the collective response of the planet’s best-informed investors.
The MSCI World index reflects the judgement of major investment players by using a market cap weighting method. This means that the proportion of an index devoted to any one company is aligned with its share price. So the most highly valued company in the world will take up the largest proportion of the index, the second company will be ranked as the next largest and so on.
When global investors decide it’s time to move money out of the UK and into the US, for example, you don’t have to lift a finger. An MSCI World ETF will reflect the change in outlook automatically.
The MSCI World is the best known global index and is to Planet Earth what the FTSE 100 is to the UK or the S&P 500 to the US.
It tracks around 1,600 of the world’s largest companies – immunising you against the risk of a single firm going bust. Recalling the fate of Enron or Nokia is a stark reminder that once-dominant companies can fall from grace. But individual corporate disasters barely affect the MSCI World when even Apple is worth just over 2% of the entire index.
If a catastrophic product failure smashed Apple’s share price by 50% tomorrow that would only translate into a 1% loss for the MSCI World. Major Apple shareholders would be devastated but globally diversified investors would scarcely feel a thing.
The 10 largest holdings amount to just 12.5% of the MSCI World – a sign of a well-diversified index.
Top 10 MSCI World constituents
Source: MSCI World; as of 31/05/2019
By comparison, the FTSE 100’s top 5 account for 29% of the entire index. That exposes investors to concentration risk and you don’t have to cast your mind back far to remember that huge Footsie players like HSBC, Shell or BP have been rocked by large and unexpected difficulties in the recent past.
A related issue with many individual countries is that their stock markets are often heavily biased towards certain business sectors. For example, the FTSE 100 is 14% oil and gas firms but the technology sector accounts for less than 2%. By comparison, the MSCI World is 16% tech and gives you exposure to global giants like Alphabet / Google, Facebook and Microsoft.
Tracking a world index also guards against home bias: the common investing mistake of overweighting your own country in your portfolio due to the inbuilt human habit of confusing familiarity with safety.
The problem with home bias is that your portfolio and other sources of income like your job become tied to the same risk: the chance of your home country being hit hard by economic turmoil.
By contrast, a globally diversified portfolio can act as a hedge against trouble at home. When the pound plunged after the Brexit vote, globally diversified UK investors watched the value of their portfolio soar as their dollar and euro-denominated investments appreciated.
Granted, some commentators note that over 60% of the MSCI World index now tracks US companies. But US concentration concerns neglect the fact that its stock market is the most diversified in the world. Moreover, many US firms are huge global players that earn more than half of their profits in the rest of the world. Finally, if you decide to diverge from the global market consensus, you have to ask yourself what you know that the world’s biggest financial players do not.
You can take diversification one step further by investing in an ETF that tracks the MSCI All-Country World Index (MSCI ACWI). This index expands the MSCI World universe with 26 emerging market countries including the BRICs (Brazil, Russia, India and China).
Emerging markets are characterised by greater volatility than their developed world counterparts but are also expected to deliver greater growth in the long term.
The MSCI ACWI index is just over 12% in emerging markets which enables more risk-averse investors to enjoy the benefits of greater diversification and the potential for stronger growth while keeping the bulk of their investments in developed markets.
Of course, many investors like to refine their strategy with single-country ETFs as they grow in experience and confidence.
That approach can yield strong results if you make the right picks, but you should feel no pressure to go down this road.
In fact, a World Index ETF is a key building block that earns its place in any investor’s portfolio – especially if you’re looking for a solid start point and don’t want to spend time juggling multiple equity funds.
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