International investing existed before 1986, but it was very different than what it looks like today.
In 1969, the EAFE (Europe, Australasia, and Far East) index was created by Capital International, a unit of The Capital Group. The Capital Group wanted to invest internationally, but couldn’t find good data, so they created their own index to track foreign markets.
From 1972 – 1974, US investors could buy foreign stocks, but they were taxed an additional 15% on the purchase price. This was called the Interest Equalization Tax (IET). This tax was designed to prevent US investors from sending their money abroad and to instead keep their money at home.
The IET was repealed in 1974, but there were no international index funds to buy. US investors had to use stock brokers to pick and choose individual foreign stocks to add to their portfolio. This was risky and stock brokers would charge high fees.
In 1981, Vanguard launched the International Growth Fund (VWIGX). This brought more streamlined international investing to US citizens at a low cost, but it was actively managed. The fund managers would still pick and choose specific stocks. They weren’t following an index.
Finally, in 1986, Morgan Stanley bought the data rights from Capital International and rebranded as MSCI (Morgan Stanley Capital International).
This marked the first year of standardized data for MSCI indices that are still used today.
US Equity Style CAGR (1972 – Present)
The three big MSCI indices that “started” in 1986 were: MSCI EAFE, MSCI Europe, and MSCI Pacific.
Note: If you use Portfolio Visualizer, you might notice a discrepancy. In 1986, Global ex-US and Developed International markets were basically the same. At that time, there were no emerging market indices. So, Global ex-US was only consisted of Developed International markets.
To keep things simple, I’m going to focus on Developed Markets, European, and Pacific from 1986 to present.
In my future article on equity returns from 1995 to present, I will separate Global ex-US (because it will contain developed and emerging markets) and Developed International.
“Note: Performance data prior to 1992 represents theoretical academic research (Fama-French Data Library) rather than investable mutual funds. Actual investors during this period would have relied on active managers (like the Vanguard Windsor Fund) who faced transaction costs and fees not reflected in this theoretical data.”
Note on International Data: The performance data for “International Stocks” (or Global ex-US) prior to 1996 typically represents the MSCI EAFE Index. This index tracks only “Developed Markets” (mostly Europe and Japan) and does not include Emerging Markets, which were added to standard retail funds later. Additionally, pre-1996 data is theoretical and does not account for the high trading costs or management fees of the active funds (like Vanguard’s International Growth) that investors relied on during that era.
1986: International Indexing Began
MSCI launched their three new international indices in 1986. Here’s a quick breakdown of each and how I will refer to them going forward. I also included a current ETF that you can research. While the ETFs I mention don’t specifically track the MSCI indices, they are well known and popular ETFs for international investing.
- Developed International (MSCI EAFE)
- These are wealthy, industrial, and economically stable foreign countries (Japan, United Kingdom, Canada).
- ETF: VEA
- European Markets (MSCI Europe)
- Mostly developed Western European countries (Germany, France, United Kingdom).
- ETF: VGK
- Pacific Markets (MSCI Pacific)
- Developed Pacific countries (Japan, Australia, South Korea)
- ETF: VPL
When more international markets became available for investors, that meant that the competition between equities heated up.
CAGR Performance: The US vs. The World
Here is a table of the CAGR’s of US and International Equities from 1986 to present:
Although international markets became indexed and tracked, they still underperformed the US Market.
The US Market had a CAGR of 11.06% from 1986 to present.
The new international equities had CAGRs of:
- Developed International = 7.35%
- European = 8.74%
- Pacific = 5.9%
Compared to the US Market, international equities underperformed by:
- Developed International = -3.71%
- European = -2.32%
- Pacific = -5.16%
Case Study: Returns of US Market vs. Developed International
Let’s say that you decided to invest $10,000 into the US Market and $10,000 into Developed International in 1986.
You didn’t invest any extra money. The $10,000 just sat there and compounded year after year for 39 years.
Here’s the difference in returns over that period of time.
US Market: $10,000 compounded annually at 11.06% for 39 years = $598,065.98
Developed International: $10,000 compounded annually at 7.35% for 39 years = $158,957.09
That’s a difference of $439,108.89!
While you might look and see only a 3.5% difference between the CAGRs of the US and Developed International markets, that is a huge difference in returns when taking into account the power of compounding over long periods of time.
It’s why looking at CAGR is so important for investors.
The Debasement Battle: Did US & International Equities Outperform the Money Supply?
The M2 Money Supply had a CAGR of 5.67% from 1986 to present.
Fortunately, US and International equities outperformed the CAGR of the money supply, but there was a wide range of outperformance.
US equities outperformed the CAGR of the M2 Money Supply by 3.85% to 6.84%. This outperformance represents real productivity and wealth creation.
Meanwhile, International equities did outperform, but by not as much as US equities did.
In fact, Pacific equities barely outpaced M2 Money Supply by .23%.
Did International Diversification Beat the U.S. Market?
Short answer, no.
The total US Market had a CAGR of 11.06% per year.
Developed International, European, and Pacific equities did not outperform the US Market from 1986 to present.
Pacific markets (5.9%) barely outperformed the increase in the US M2 Money Supply (5.67%).
However, this was over the course of 38 years. There were individual years where international outperformed the United States, but over the long run, the United States had superior returns.
Why International Investing Still Matters
It’s easy to look back at the data and think “well I should have only invested in the United States”. But no one can predict the future. No one has any idea whether international markets will underperform or outperform in the future.
International diversification still has a place in investing. What if the next big company starts somewhere overseas? Investing solely in the United States wouldn’t give you that exposure.
What if the US goes into a recession and other countries don’t?
International diversification just means that you’re admitting to yourself, “I have no idea what country is going to perform well in the future, so I’m going to bet on all countries”.
Will your returns be as good if you just picked the best country? Of course not.
But there is risk in picking one country and betting that it’s going to be the best however many years into the future.
That’s why international diversification still matters.