Given the prolonged bull run of the U.S. stock market, you might think that the U.S. leads the world as the premier country for investment. Indeed, the U.S. is one of the premier countries for investment, but over the last decade, it has not provided the highest annualized return.
A recent article by David John Marotta, President of Marotta Wealth Management, makes the case that while returns on American investments are solid, they may be improved upon through greater economic freedom (via less regulation and lower taxes).
Using the Heritage Foundation Index of Economic Freedom, Marotta compared the average annualized returns over the past ten years (through June 2014) of the S&P 500 and the six nations that received the economically “free” designation in the Index. The 10-year annualized return of all six of those nations topped the 10-year annualized return of the S&P 500.
The six nations, in order of their economic “freedom” ranking, are Hong Kong, Singapore, Australia, Switzerland, New Zealand, and Canada. The average return from all six of those nations is 11.34%, with the highest being Australia at 12.82% and New Zealand coming in at 9.11%. By comparison, the return of the S&P 500 is just 7.78%.
For another benchmark, consider the MSCI EAFE index of developed countries. The EAFE index (standing for Europe, Australia, and the Far East) has a 10-year annualized return of 7.42%, coming in at 3.92% below the so-called “freedom average”.
Note that with the exception of Canada, the countries designated as free are also members of the EAFE. Those five countries had to drag the rest of the EAFE along just to make the 7.42% level.
Where is the United States in the freedom index? We rank 12th, just behind Estonia and just ahead of Bahrain. By the Heritage Foundation’s methodology, we are primarily held down by our increasing levels of regulation, levels of government spending, and lack of business freedom.
The article is clearly written from a libertarian point of view, but there are some valid points to be made whether you believe in libertarian philosophies or not.
It is certainly true that, as Marotta points out, had you invested $1 million in the economically “free” countries at the beginning of the 10-year period you would have come out considerably ahead. The EAFE would have left you with $2.05 million, the S&P 500 with $2.12 million, and the average of the six free economies would have left you with $2.93 million.
It is also completely logical to argue that an economy that is free by the Heritage Foundation’s definition – limited regulation, strong property rights, little corruption, the strong rule of law, and generic market freedoms – should give greater returns on average than an economy with greater restrictions.
To us, the real takeaway from this article is that diversification of your portfolio should include a global component, and not just from the viewpoint of high-risk, high-return emerging markets. Foreign investment in developed countries can clearly provide high returns, and may be optimized with a little time and research.
Keep in mind that even though the “free” economies outperformed the S&P 500, there are winners and losers within those markets, just as there are within the index. Research your stocks and use your judgment just as you would with any other stock, and you should be fine regardless of your definition of how free an economy should be.