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A woman holds U.S. and Canadian flags on Parliament Hill in Ottawa, February 19, 2009.Christinne Muschi/Reuters

Recently a reader took me to task for a column in which I discussed a hypothetical all-Canadian dividend stock portfolio.

"I do not believe that many investment advisers would recommend investing only in Canadian common or preferred shares," the reader wrote in an e-mail. "As you know, the Canadian market is only a small percentage of the world capitalization."

You've probably heard the argument before: Because Canada accounts for only about 4 per cent of global stock market cap, you need to invest a big chunk of your assets the United States and abroad to make sure you're adequately diversified.

Does this argument really hold water? I'm not so sure.

Full disclosure: I own a handful of U.S. stocks – McDonald's, Procter & Gamble, Johnson & Johnson and Wal-Mart among them – because I think they're great companies. But that's all the foreign content I have, and it's less than 10 per cent of my portfolio.

The rest is all in Canadian companies (and GICs), and I'm not planning to deploy any more of my money abroad, for a few reasons.

First, stock markets around the world are highly correlated, so it's hard to see the benefit in diversifying internationally as long as Canada is going to follow global trends anyway. Second, venturing outside Canada means taking on currency volatility.

Sure, currencies can work in your favour, but they can also bite you in the behind. Canadians who invested in the U.S. market over the past 10 years, when the loonie surged from 63 cents (U.S.) to more than $1, probably regret ever leaving the home.

Over that 10-year period the S&P 500 returned a solid 115.8 per cent, including dividends, or an annual equivalent of about 8 per cent. But in Canadian dollars the gain was a paltry 34 per cent, or just 3 per cent on an annual basis. Yikes.

As this example illustrates, the notion that currency fluctuations will even out in the long run – one of the key arguments in favour of diversifying globally – is also suspect. It's not like hedging will necessarily solve the problem, either, because hedging doesn't always work as advertised.

Consider the currency-hedged iShares S&P 500 Index exchange-traded fund (ticker: XSP). Even as the S&P 500 index gained 8 per cent annually over the past decade, this supposedly currency-neutral ETF returned just 3.3 per cent.

For all of the above reasons I'm not in a big hurry to invest more of my money abroad, and I know I'm not alone. I've heard from plenty of readers who think a 100-per-cent Canadian portfolio suits them just fine.

Readers: What do you think? Are investors who stay close to home missing out? Is hedging all it's cracked up to be? Is it time we all started questioning the global diversification dogma?

Leave us your thoughts in the comments section.


Another note to readers: Thanks for all your feedback on my last blog post about the limitations of Canadian index ETFs. Some of you pointed out that specialty ETFs provide better diversification than a straight Canadian index ETF, and that the higher management expense ratios are therefore justified. It's a good point. If you look at the iShares S&P/TSX Canadian Dividend Aristocrats Index Fund (ticker: CDZ), for example, it's delivered an annual return, including dividends, of 3.8 per cent over the past five years. That's hardly shooting the lights out, but it's a lot better than XIU's negative return.