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Resetting expectations for U.S. and international equities

U.S. investors are likely to be rewarded for holding international stocks in the decade ahead. “Geographic diversification can help mitigate volatility in a portfolio,” said Ian Kresnak, CFA, a Vanguard investment strategy analyst, “But in the current environment, we also view it as a good opportunity for U.S. investors to achieve higher relative returns, as the drivers of U.S. stock outperformance over the last decade have likely sown the seeds for their underperformance over the coming one.”

The structural case for international diversification: Lower expected volatility

A key tenet in investing is that broad diversification can help reduce volatility. Investors may not recognize that investing solely in domestic stocks carries idiosyncratic risk, even if their portfolios are broadly diversified in their home market. In doing so, they forgo exposure to an array of economic and market forces in other countries that tend to produce returns different from those of their home market.

“Country risk is like sector risk,” said Kresnak. “They both tend to lead to greater volatility that could be mitigated through broader diversification.”

The cyclical case for international exposure: Higher expected returns

Over the past decade, a broadly diversified U.S. stock portfolio would have returned almost twice as much as a comparable international portfolio for a U.S.-based investor.* “Disappointing returns may have some investors reconsidering their allocation to non-U.S. stocks,” said Kresnak, “But there’s reason to believe the next decade could look very different.”

The top panel in the figure below breaks down how U.S. stocks managed to produce an average annual return that was 7.5 percentage points more than that of their international peers from April 1, 2013, through March 31, 2023.

Rising stock valuations and higher earnings in the U.S. were the biggest factors behind the differential. Valuations expanded faster in the U.S. because investors expected the American economy and earnings to grow faster than a market-cap weighted average of their international peers and they did. Still, valuation expansion rose more than our fair-value framework would suggest based on interest rates and inflation. Altogether, this contributed 3.3 percentage points of outperformance for U.S. stocks compared with their international counterparts.

Earnings growth added another 3.2 percentage points, a result of stronger margin growth and significantly faster revenue growth than was seen internationally. A U.S. dollar that strengthened over the last decade subtracted 2.1 percentage points from international returns, which more than offset 1.1 percentage points of outperformance due to higher dividend yields.

The bottom panel in the figure below forecasts a turnaround, with an average annual outperformance for international stocks of 2.2 percentage points from March 2023 through March 2033—an outcome based on our median projections of U.S. stocks returning 5.1% and international stocks 7.3%.

U.S. stocks are unlikely to repeat their past outperformance over the coming decade

Notes: Valuation expansion is estimated as the year-over-year percentage change in the price/trailing 3-year average earnings ratio. Earnings growth is the total ex-dividend, ex-valuation expansion, ex-currency return. Foreign-exchange return is estimated as the return on the trade-weighted USD.

For the past 10 years, U.S. stocks are represented by the MSCI USA Index and international stocks are represented by the MSCI ACWI ex USA Index, from April 1, 2013, to March 31, 2023.

Return estimates for the next 10 years are from the Vanguard Capital Markets Model (VCMM) for the period from April 1, 2023, through March 31, 2033; U.S. stocks are represented by the MSCI USA Index and international stocks are represented by the MSCI ACWI ex USA Index.

Returns do not take into account management fees and expenses, nor do they reflect the effect of taxes. Returns do reflect reinvestment of dividends and capital gains. The two bars representing U.S. and international expected returns are median expectations. As a result, this comparison does not account for the correlation between U.S. and international equities.

Sources: Vanguard calculations, based on data from Refinitiv and Global Financial Data, as of March 31, 2023.

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from VCMM are derived from 10,000 simulations for each modeled asset class. Simulations as of March 31, 2023. Results from the model may vary with each use and over time.

More headwinds than tailwinds for the U.S.

We expect to see stock valuations return closer to our estimates of fair-value across the globe—particularly in the U.S., where more pronounced valuation expansion has pushed them to loftier levels. A contraction in valuations of 1.2 percentage points abroad and 1.6 percentage points in the U.S. would result in a performance advantage for international stocks of 0.4 percentage points on average per year over the next decade.

By our estimates, the U.S. dollar is valued about 12% above what long-term fundamental drivers would suggest. The run-up to a strong dollar has hurt international equity performance for a U.S.-based investor in the past, but during the decade ahead, a weakening dollar could add about 1.1 percentage points to international stock returns compared to their U.S. counterparts.

Some trends, however, aren’t expected to change. Dividends of international stocks should remain higher than those in the U.S., adding about 1.4 percentage points of outperformance. And earnings growth will likely remain a tailwind for U.S. stocks in the coming decade, resulting in a modest return contribution of about 0.7 percentage points over international stocks.

International allocation: How much is enough?

From a structural perspective, having an allocation to international stocks makes sense because broad geographical diversification can help reduce volatility in a portfolio. Using a market-capitalization-weighted approach, such an allocation would be roughly 60% domestic stocks and 40% international stocks. A mix in that range could make sense in the equity portion of broadly diversified multi-asset investment products used by self-directed investors.

But there are practical considerations—implementation costs, tax repercussions, regulations, and investment costs—that could lead an investor to consider a different international allocation. And in an advice setting, more personalized costs and tax considerations may be considered to help refine the allocation mix.

From a cyclical perspective, investors with the requisite time horizon, risk tolerance, and interest in an active investment management strategy may consider a modest overweight to international stocks given the prospect that they may outperform over the next decade.

Our base case is supported by the figure below, which shows a preponderance of market return simulations in which international stocks return more than domestic stocks over the next decade. Our simulations suggest that a 60% stock/40% bond portfolio with a market-cap weighted allocation to international assets is expected to return 0.6 percentage points more per year on average and 0.4 percentage points less expected volatility than a domestic-only portfolio.

The figure also shows that there’s a reasonable probability that U.S. stocks could continue to outperform. According to our simulations, however, the likelihood of U.S. stocks outperforming in the coming decade by as much as they did over the last decade is less than 1%.

International stocks outperform in most, but not all, of our outcome simulations

Note: Figure shows the results of 10,000 Vanguard Capital Markets Model simulations for projected 10-year annualized returns for the period from 2023 through 2033.

Source: Vanguard, as of March 31, 2023.

IMPORTANT: The projections and other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from VCMM are derived from 10,000 simulations for each modeled asset class. Simulations as of March 31, 2023. Results from the model may vary with each use and over time.

The takeaway

“As we’ve noted many times before, forecasting is a humbling exercise,” said Kresnak. “That said, we believe U.S. investors would benefit from lower volatility through an allocation to international stocks.

And over the coming decade, it will likely help them achieve higher returns than a domestic-only portfolio—but with moderation being warranted, as international outperformance is far from guaranteed.”


All investing is subject to risk, including possible loss of principal.

Diversification does not ensure a profit or protect against a loss. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk, which is the chance that political upheaval, financial troubles, or natural disasters will adversely affect the value of securities issued by companies in foreign countries or regions; and currency risk, which is the chance that the value of a foreign investment, measured in U.S. dollars, will decrease because of unfavorable changes in currency exchange rates.

IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time.

The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.

The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.

* Sources: The MSCI USA Index return was used as a proxy for the U.S. stock portfolio and the MSCI ACWI ex USA Index return was used as a proxy for the international stock portfolio. The decade referred to is from April 1, 2013, to March 31, 2023.

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