Human nature has an inherent tendency to shy away from change and the unknown, gravitating instead toward the comforting embrace of familiarity. This inclination weaves its way into every facet of our lives, even into the realm of investments. If you observe those around you, you'll find many investors who have invested mostly, if not entirely, in their home market. It's a comfortable choice, a psychological sanctuary, a place where they feel safe and secure.
However, investing in your home ground does not necessarily translate to enhanced performance or safety. In fact, it is for the same exact reasons that we should also look for opportunities beyond the confines of our domestic market.
In this post, I will introduce you to the largest and most developed financial markets in the world - the US financial markets. And the reasons why you should give serious consideration to diversify into the US markets if you have not done so.
1. The US financial market is the largest in the world
The US financial market, after so many years, is still undisputedly the largest in the world. The size of the US equity market by market capitalization as of 2Q 2023 is USD 46.2 trillion and that accounts for 42.5% of the global equity market. This is 4 times larger than the next contender Europe and more than 70 times the size of Singapore’s equity market (source: SIFMA).
Likewise, their fixed income market also holds the top spot with its sheer size at USD 52 trillion as of 4Q 2022. This is a massive 40% of the USD 130 trillion fixed-income securities across the globe. In comparison, Europe, the next largest market, is 2.3 times smaller, while Singapore's fixed income market is just 1/80 of it (source: SIFMA).
2. The US financial market has a long history and holds a wealth of reliable data
The US markets also have one of the longest, most reliable, and transparent financial market data in the world. This is critical for all serious investors trying to navigate any financial market and even more so for quants who depend on good-quality data to build models and validate ideas. Because data is the starting point and if it can't be trusted, everything else collapses.
And what makes US stock market data reliable? There are many contributing factors. Strong regulatory oversight, stringent financial reporting standards, high-end exchange and market surveillance infrastructure, and the presence of established data providers such as Bloomberg and Reuters are some of them. The sheer size and liquidity of the public markets with worldwide participants also add an additional layer of resilience, making it challenging for anyone who attempts to manipulate or fudge public data.
3. Ultra-low transaction costs
Long gone are the days when brokers charge 0.2% to 0.4% per trade and $30 minimum commissions. These days the commissions are much lower. And if you go for large established US brokers such as Interactive Brokers, the rates are even more competitive. The commission on a stock priced at USD 50 is only about 0.01% with a minimum commission of USD 1.
To attract retail investors, there are also brokers who offer comms-free trading. But they don’t necessarily mean you pay less in the end. You just can't tell easily what you pay now. Because what most of these brokers do is sell their order flows to other market makers. As a business, they have to make their money somewhere. So, if they don’t charge you, that means someone else is paying for it. What that means for you is that you may actually end up paying more instead because of less favorable price executions. I did a short study comparing one comms-free broker against a comms-charging broker. Not going to name them here. On average, the bid-mid spread of the comms-free broker is more than 3x that of the comms-charging broker. You can probably find much better comms-free brokers around than the one I looked at but do make comparisons before you plunge.
4. Ability to trade in fractional shares
Today, there are US brokers that allow you to trade in fractional shares up to the smallest unit of 0.0001 shares. This is an important development for retail investors with smaller capital. In the past, proper diversification was only achievable by large institutions. However, lower trading costs and the ability to trade in fractional shares have closed this gap. It allows retail investors today to participate in meaningful diversification, and the ability to size up their trades more precisely.
5. Wide range of securities stocks, ETFs, mutual funds
The ability to construct properly diversified portfolios and the kind of strategies you can implement is driven by what kind of securities you can access. And you will find no other markets that offer retail investors anywhere close to the breadth and depth of the US financial markets - More than 6000 publicly listed companies across NYSE and NASDAQ (source: Statista), 2900 ETFs in different asset classes (source: ycharts.com), 7000 mutual funds (source: Statista), and a wide range of futures and options across equities, bonds, commodities, forex, and the only market that offers liquid volatility products. This opens up opportunities to run strategies that you would not be able to implement in other markets.
6. The broad US stock market is strong and has outperformed most other markets since 1994
The US stock market has outperformed its peers from 1996 to 2023 in a comparison with the stock market of Singapore, Hong Kong, Japan, Australia, the UK, and Germany. The prices of the ETFs are used to calculate the performances of these markets. For the US, the S&P 500 ETF (Ticker: SPY) is used, and for the rest, we used Ishares ETFs representing the MSCI index of the respective countries (Singapore: EWS, UK: EWU, Germany: EWG, Australia: EWA, Japan: EWJ, Hong Kong: EWH)
All returns are measured in USD terms (forex gains or losses are accounted for), and all dividends paid are reinvested. In this exercise, the US emerged as the top performer delivering a CAGR of 9.1%. If we drill down further, it not only outperformed by a considerable margin in terms of returns, but its risk and maximum loss experienced during the period are also the lowest.
7. The US financial market is still the goto market in times of crisis
Not all safe havens are the same. In times of a deep crisis, the defacto choice investors park their money in is still the US Treasuries. The US enjoys certain privileges not just as the strongest economic power but also because the USD is the world’s reserve currency. The USD dominates in trade settlements and is deeply entrenched.
As of the end of Q1 2023, 59% of the global currency reserves are held in USD. Euro comes in a far runner-up at 19.8% and the Japanese Yen next at 5.5%. The up-and-coming China RMB accounts for less than 3%. Even though USD’s dominance has declined over time, overtaking it will still be an extremely daunting undertaking even if promising candidates appear. Even with waning influence, the USD will remain the dominant or if not one of the dominant currencies for many more years to come.
8. SIPC protects up to USD 500,000 of your cash and securities in the event a broker fails.
Most US brokers have multiple levels of safeguards in place to protect their clients' assets. For example, regulators will require them to keep customer assets in accounts segregated from their own company accounts so that creditors have no claim to them, and have a minimum amount of liquid assets on hand to meet emergency needs, etc. And even in the rare event that all these fail, if your brokerage firm is a SIPC (Securities Investor Protection Corporation) member firm, SIPC protects the securities and cash in your account up to USD 500,000 (commodities, futures, hedge funds, private contracts, etc. are not covered). Some brokers may provide even higher levels of protection through added insurance arrangements.
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