Allocate 50% to Non-U.S. Stocks, According to Wharton Professor

International is everywhere.

That's nothing new, of course—by definition and with respect to “recommended” diversification of investment portfolios. One of my earlier personal-finance-book purchases, The Wall Street Journal Lifetime Guide To Money, was published in 1997. It recommended people in their 20s and 30s have their portfolios 20% in “foreign stocks”—and people in their 40s and 50s have their portfolios 15% in “foreign stocks” (the book having a U.S.-perspective in discussing “foreign stocks”).

With the current state of the U.S. economy and the weakening U.S. dollar, the emphasis on diversification including non-U.S. stocks only seems to be increasing. I was recently listening to a personal-finance commentator on the radio (I think it may have been Rob Black), and he seemed to find appeal only in stocks that had international exposure in their underlying businesses.

Still, I had in mind that a 20% allocation to non-U.S. stocks—or perhaps a 30% allocation for a somewhat more aggressive portfolio—was more or less where the personal-finance conventional wisdom lay.

But the May 5, 2008 issue of BusinessWeek reports that Wharton professor Karen K. Lewis finds that, “The ideal amount to have in foreign stocks is… 50% of assets.”

This is apparently the conclusion from her most recent research—and a body of work in crunching data on U.S. versus non-U.S. stock investments. She also found that the effectiveness of diversification into non-U.S. stocks is less than it once was—as U.S. and non-U.S. stocks move together more in step these days—but that this diversification is still worthwhile.

Digging around, I found an abstract of Professor Lewis’s paper and excerpt this part:

To consider the economic significance of these parameter changes, I use the estimates to examine the implications for a simple portfolio decision model in which a US investor could choose between US and foreign portfolios. When restricted to holding foreign assets in the form of market indices, I find that the optimal allocation in foreign market indices actually increases over time. However, the optimal allocation into foreign stocks decreases when the investor is allowed to hold foreign stocks that are traded in the US. Also, the minimum variance attainable by the foreign portfolios has increased over time. These results suggest that the benefits to diversification have declined both for stocks inside and outside the US.

I couldn't find the full paper available without shelling out some money—but this excerpt seems to suggest Professor Lewis’s recommendation would be concentrated on foreign market indices.

Apparently, Professor Lewis has long been recommending greater allocation to non-U.S. stocks then U.S. investors follow—concluding there is an “equity home bias” that causes investors to favor their home country. In her May 1998 paper on these biases (PDF), Professor Lewis noted:

Indeed, a portfolio of 100% share in the S&P 500 is dominated by all portfolios with foreign share of about 39%... Nevertheless, estimates from the literature put the share of US holdings of foreign equities at about 8%,…

The BusinessWeek article notes that Professor Lewis’s more recent study observes U.S. investors’ portfolios are 12% in international stocks—a mild uptick from the observations of her 1998 paper of 8%—but still much less than her recommendation at that time of 39% and current recommendation of 50%.

We’re certainly nowhere near 50%. How about you?