Economists would argue with this logic, particularly over the long term. But investors are more concerned to act in a way they think will maintain their short to medium spending power in the home country.

Accepting reality …

The financial economists may be right in theory. In practice, the argument just doesn’t feel right for most people. Is there a basis for reasonable compromise?

Explanation: Australian shares ("Aus") represented by S&P/ASX500 Accumulation Index International shares ("Int") represented by MSCI World Index (net of dividends) Based on monthly rebalancing; standard deviation calculated on a monthly basis and annualised

It shows that as the international share component increases from 0% to about 40%, volatility reduces. Beyond 40%, there is little gain from further increases in the allocation to international shares .

Pragmatism rules …

Based on this analysis, a pragmatic approach suggests that share investors hold at least 30-40% of their allocation in international shares. This will provide some diversification benefits and is likely to reduce the overall volatility of share portfolios.

But in following this approach, investors should not delude themselves that they are maximising their expected risk adjusted return. Why?

Because it implies that they continue to hold 60-70% of their share portfolio in Australian shares. However you look at it, this is a big bet on a market that only represents about 2% of world share markets!

At least investors are making the decision with their eyes wide open.

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