“Would you rather put your money in companies founded in North Korea or in South Korea?” This is the opening thought experiment posed by Megan Russell of Marotta Wealth Management. The difference between the two is obvious. Do you want your money sitting in a state-controlled environment like North Korea or in a more economically free country like South Korea? It’s important to understand global investments and how they fit into your overall investment portfolio.
You can listen to Megan Russell and I chat about Freedom investing on a recent episode of my podcast. We explore Marotta Wealth Management’s ideology and strategy with regard to Freedom Investing. Megan is no stranger to the topic. On her blog, Marotta on Money, she has spent years exploring this topic and has an admirable history of openly sharing her strategy and results. Megan has done a lot of first-hand research in this area and shares her expertise on the show and in what follows.
The simple thought experiment above was meant to give you pause for thought. What does it mean to invest in an economically free environment? For starters, companies without state control can pursue profits, hire and fire employees, and innovate without fear of retribution. Freedom to explore opportunities is not a given around the globe. It makes sense to avoid companies operating under a regime that can change the rules at a moment’s notice, potentially wiping out your gains.
How do you go about determining which countries are “economically free?” Luckily, you don’t have to figure it out on your own. The Heritage Foundation has developed an Index of Economic Freedom. Countries are evaluated on a number of criteria including, but not limited to, labor and monetary freedom, government spending, and tax burden. The list is updated yearly and offers results on a scale from 0-100 which allows you to take a deeper dive into the component parts.
In terms of strategy, the idea is to invest your money into countries where the operating environment is on the high end of the economic freedom scale and avoid those countries that fall on the low end. It makes intuitive sense that the local laws and culture will greatly impact the success of a company, but what do the numbers say?
Megan and the Marotta on Wealth blog offer insightful details about the specifics of Freedom Investing. You can read a variety of articles on their website that include backtesting and refining results if you want to immerse yourself in the details. I’ll give you some tips for implementing the strategy a bit further along in this article but let’s first explore just how much of a difference it could make.
Megan found in her backtest of their current strategy that “basically the average advantage of freedom investing is a 2% annual advantage” over the MSCI EAFE index.
In "A 25-Year Review of Freedom Investing", Megan explains how compared to the EAFE, "on average Freedom Investing has a 1-year advantage of 2.093%, 5-year advantage of 1.995%, 7-year advantage of 2.314%, 10-year advantage of 2.400%, 15-year advantage of 2.392%, and 20-year advantage of 2.073% over the EAFE Index."
The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia, and the Far East, excluding the U.S. and Canada. It covers approximately 85% of the free float-adjusted market capitalization in each country.
This is a good benchmark for comparison because the Freedom Investing strategy is investing in developed markets outside the US.
As is always the case with factors, in the backtests of results over varying lengths of time sometimes Freedom does better and sometimes not, but, Megan writes, "of the 293 measured 1-year periods, Freedom Investing lost to the EAFE Index in 96 of them" while "of the 185 measured 10-year time periods, Freedom Investing lost to the EAFE Index in 0 of them."
While 2% may not sound like much, let’s take a closer look. Say that you invest $10,000 and assume the EAFE Index gets a 6% annual return and Freedom Investing returns 8% per year. After 1 year, you are obviously ahead by only $200 ($10,800 in Freedom versus $10,600 in EAFE). By year two Freedom Investing is ahead by $428 and in year three that’s $686. But compounding continues its yearly march and after 20 years the Freedom Investing account has outgrown the EAFE account by $14,538 or 45%! That’s 45% more money by investing in countries that are freer.
Does this investment strategy come with more risk? We typically measure risk by the standard deviation of returns, or volatility, which is how much the portfolio goes up and down. This is a terrible way of measuring your risk, but it’s the industry standard for portfolios. By that measure, looking backward with actual results, it turns out that Freedom investing had a superior risk-adjusted return. You can read more about this in Megan's "Risk-Return Analysis of Freedom Investing."
As mentioned above, this strategy is to invest in developed countries with greater degrees of economic freedom and not include those with heavy restrictions. The US is near the top of the economic freedom index (currently 20), and that’s essentially where the line is drawn: those above the US are freer and those below should not be included in your portfolio. However, not all of those 20 countries have large enough markets to warrant investment and there are some other nuances to take into consideration (listen to the podcast for more discussion on this topic).
Since these are developed countries outside the US, it makes sense to think about this portion of your portfolio as the International (not including Emerging Markets), or the ex-US developed countries.
Notably, there are two countries that are more free than the US, large enough to warrant investment but lie within the FTSE emerging markets, rather than developed markets: Taiwan and Chile. There’s no technical definition of what is an emerging or developed country but generally, developed countries have more advanced economies and mature markets. And most importantly for us, companies that maintain market indices define which countries are part of which index. Since emerging markets have their own risk/reward and different labor forces at play, it makes sense to separate them from developed markets.
You might feel confident replacing your developed market (index) investments with the freedom investing strategy discussed here since it includes approximately 10 different countries. This keeps your international investments well diversified. On the other hand, since emerging market indices generally include 20+ countries, only investing in Taiwan and Chile may not be diversified enough.
So, how do you actually put this strategy to work within your portfolio? Aside from the obvious: compiling research and determining what works best for your situation, you should also consider the following (in order from most to least complicated):
What I love about Freedom Investing is that the strategy makes intuitive sense and the backtesting results support the concept. Furthermore, it feels good to put your money in business owners that are allowed to operate with freedom and own the rewards. Investing in countries that allow businesses more freedom to operate is a win-win-win.
I want to extend my sincerest gratitude to Megan and her firm for openly providing so much information about this Freedom Investing strategy and beta testing results for many years. I’m not a fan of complicated investing. Freedom investing is a strategy I use because it’s simple to understand and easy to execute as a buy-and-hold investment.
If you have any questions or comments, please feel free to reach out!
The following is the list of country-specific funds Megan's team uses in their implementation:
To read more about Marotta Wealth Management's latest updates on their Freedom Investing strategy, you can browse their articles on the topic here.
That was our last show and it was great. So Megan, welcome back to the show today.[:
[00:00:28] Mike: My pleasure. I said this last time, when we got together that I am a massive fan of Megan's work at Marotta wealth management, their blog posts are unbelievable. The weekly newsletters. Amazing. Everyone should subscribe to that.
Fascinating tips and tricks. And what I love about it too, is it's consistent. You're hearing the same messaging over and over about saving consistently investing consistently and all of that. And I really appreciate that constant.[:
[00:00:59] Mike: So a quick intro for those that weren't with us last time, Megan Russell works as worked in finance. Most of her life. She is the chief operating officer at Marotta wealth management. She's written over 700 financial articles. And can be found at Marotta on money and today's topic I'm really interested in diving in because this is something I discovered probably over 10 years ago on the Marotta wealth management blog.
And I know they've been writing about it for over 15 years and the topic is freedom investing. And the idea at a very high level is just to invest in more free countries. Which seems to make sense off the top. So why don't we just start there, Megan? What do you mean when we talk about freedom investing?[:
There's corruption at every level in North Korea. I cannot imagine being a business and thriving there. So the simple thought experiment reveals how the freedom of a country can play a role in the success of the businesses that operate there. So expanding that concept, it would be if you were to pick off the top, the most free countries of the world, the thought experiment would suggest.
They'll do better than the countries that are more repressed at the bottom. And what we found with you we've back-tested freedom investing is that's the case, the countries that have the most freedom and performing better. So freedom investing is using , those findings in your portfolio.[:
[00:02:54] Megan: That's right. So we've been using the index of economic freedom. Heritage foundation puts out the index of economic freedom every year and economic freedom. We pick that as freedom over other types of things. Cause there's a lot of ways that you can be repressed or have freedom in a country, but economic freedom affects businesses, which is going to affect those corporations that you're investing in the most.
So we focus on. Economic freedom because that's, what's going to affect your portfolio. And heritage has 12 different sub scores that they use to pull together into what economic freedom is, but on a really high level, There are all of the environmental factors that would affect the success of a business.
So how big is the tax burden? Are property rights protected? What's business freedom are they, are people able to start a business? What's labor free, but I'm like, are people able to be hired and fired easily? Monetary freedom, , do they have a stable currency? So these are all things that obviously play a big role on the success of a business.
And so that's why index of economic freedom really is a great proxy for figuring out what's the environment that these corporations are living in.[:
[00:04:41] Megan: right. And innovate and just create more. Yeah.[:
those indexes, they have like hundreds and hundreds of different factors. Besides the, economic freedom index, are there other places that you're pulling data or is it mostly just that one?[:
So we cap weight. We've also found that there's a little bit of certain sectors that perform better, but that's separate from freedom investing. And when we implement freedom investing, we have a little bit extra that we tilt towards healthcare. So we have a little bit of a sector tilt, but again, the core of freedom investing is just picking off the top, the free countries.
And that alone has an advantage.[:
[00:05:47] Megan: Yes, because we all have a home bias. So we want to know[:
[00:05:52] Megan: So every country gets a score between a hundred and zero. You can think about it like a grade on a test. So a hundred would be a perfect score. Nobody has that a zero would be a complete and utter failure and surprisingly, even nobody has that.free country right now on the:
[00:06:29] Mike: okay. Let's see floss. Oh, it doesn't sound too good.[:
[00:06:33] Mike: Speaking to that. Do you know a and you may not know Megan, but do. you know where the U S is mostly getting dinged? Why it's a little bit lower than Singapore or some of these other[:
So those are the three sometimes when you're like swimming in it, you're like, I don't know if it's fair, but when you read it about other countries, you're like, that's totally fair.[:
[00:07:09] Megan: yeah, so there's a little bit of a home
bias there too, but those are the three things that they didn't get[:
more specifics, in terms of the countries that.
You would be interested in investing and where do you start? Like how many countries do you go down and say, I obviously most investors are here in the U S and with that home bias, doing a lot here in the U S where do you say is eh, we might want to, draw the line at, around this level or something.[:
And. It dictates the flow of capital, but also a lot Heritage's score in there is a focused on foreign investment. And so having a really high investment freedom score, it means that your investment is probably safer in the country. So we also have the requirement that the country has to have an investment freedom score over 70.
So we combine those two together. That's our metric for picking the countries. We originally picked 75 because that was the United States. And it has been drifting a little bit. So now we're a little bit lower at 74.8, whatever. We're still drawing the line right around the United States. And when we back tested it, that was the criteria we were using.[:
[00:08:45] Megan: So the countries in the developed markets that currently make the cut are Australia, Canada, Switzerland. The United Kingdom, Denmark, Finland, Ireland, the Netherlands, New Zealand and Singapore. There's also a little bit of the like does Hong Kong banket Hong Kong used to be the very tippy top of the index of economic freedom and they just dropped it off.
For obvious reasons in the news, they dropped it off as even being its own country. So it's a little bit of a debate as to whether or not Hong Kong suddenly became unfree overnight or, is still the tippy top of the list, but it used to be beating Singapore. So there's a little bit of a Hong Kong question mark, where people can use their own discernment of whether they'd like to include that one.[:
[00:09:43] Megan: You can read 3000 more words than you want to read about it.[:
It got that. But tell me, you've done, you've mentioned back testing, how does it actually work out in practice? What are the returns.[:
So that was the metric anyways. So looking at all of the possible rolling returns that you can look at in that time period, basically the average advantage of freedom investing is a 2% annual advantage, which is pretty awesome over the IEFE which is like the longest running international index that you can use.
So I think that's really amazing. And then, the next question is did you take extra risk in order to get that? Cause less countries more concentrated. The question is maybe you're losing it on some volatility there and it would be unwise, but actually when in the back testing, it's also more risk adjusted.
You actually took less risk to get a, to get the amount of extra return that you were getting.[:
[00:11:13] Megan: Yeah. Like standard[:
[00:11:32] Megan: the EFE. Yeah[:
For listeners out there if you're going to get 2% a year, You were going to do just the compounding way better? It sounds like such a small, 2%, but that's a massive outperformance,[:
like any factor though, there's going to be years that it doesn't win. So even in the rolling, and again, you can read more words than you want to read about it, but in the really returns, there'll be whole periods of time where it's not winning, but it still means that, that month that didn't win this month, it did win.
It averages out to that to 2% annual.[:
And I was, I was impressed to see. Yeah, , part of it didn't outperform in the last year to date, whatever timeframe it was. And you're just posting that and saying, oh yeah, here's what it's done. We still believe in it over the long-term in terms of a strategy.[:
And so it's a pretty fundamental concept that, you know, that what this country, what the, this country's rules are on this corporation is going to majorly affect their ability of how much they're able to produce. So it, to me, it feels like the question just is, do you have. of measuring it not is the theory potentially sound what's so core to economics that it seems like this could produce a disadvantage advantage.
So it's just a question of, do you have the right way of measuring it? And I do think heritage, it seems like through this backtesting is a really good way of measuring.[:
Your initial example of Korea, north and South Korea, and as you were talking to, I was immediately thinking about Russia and how, companies just get taken over by the government and all of a sudden, what, if you were an investor in those companies, you'd have no idea what might happen next.
And that's your point about, the economic environment that these companies are operating in makes a massive difference towards their performance of investors, depending on what the country wants to do or their environment they're in. So yeah, absolutely.
I can't even imagine trying to start a business in a place with a business freedom score of 60 or 20. Just the daunting task, how many innovative ideas die because they can't figure out how to, collect the taxes.[:
it's just a lot easier because you just don't have all those regulations, but easier to start a business, but hard to take it anywhere. So we talked about the different country. You've rattled off the different countries, put that in the show notes. Of course, with all the links, to all the articles on this topic, you can find.
I've been reading about this for over a decade and was very intrigued and started implementing myself just in my own portfolio many years ago. And it's fancy, I just love it for a variety of reasons. Where does this fit Megan into one's overall portfolio?[:
Norm we've backed, tested it with the developed countries. Emerging is a different ball game because the cheap labor of emerging market countries has its own method of producing an advantage and it return. So it doesn't make as much sense. And honestly, most of them have a lower economic freedom score as a whole.
So you still want to have. Just emerging as a bucket. We do have some country-specific tilts that we do because Taiwan and Chile both have really high economic freedom scores. So we do have two, those two countries that we're representing, but even in. foreign strategy. We still just have a bucket for emerging, just a generic emerging ETF because China's not free, but it has cheap labor and it does produce a good return with that.
And things like that. India is not super free, but it does have the cheap labor and produces a good return from that. So anyways, so it would with a, with an emerging component, this would replace your foreign strategy. Some people don't have a foreign strategy and that's because they have such a strong home bias that they invest a hundred percent in the United States.
And in recent years that has paid off United States has one. But I will say that for the same reason that diversification among companies and sectors is responsible diversification among countries is responsible. So although. Putting all your eggs in the United States has paid off recently. I would caution people from doing that strategy over the long-term over the longterm.
Yes. Having foreign in your portfolio over the last few years has dampened your returns just as diversification always does, but over the long run, it will probably produce a more consistent return for you.[:
mentioned that, the last 10 and 20 years, I believe last two decades, the us has outperformed and that's very unusual actually, because it used to flip-flop about everyday.
400 outperform for a decade and then the U S would outperform for a decade. So it's been a couple of decades and we have very short memories use. I can barely remember what I had for lunch earlier today. So I can't remember, 20 years ago when foreign was, a better place to be invested, but I would absolutely echo what you said.
Stay diversified across global portfolio. And I would expect for him to become back at some point , probably earlier, rather than later would be my guess if I had to make one. All right. So that's
where it would fit in the, and you mentioned develop markets, so that's good. Those are the developed markets versus the emerging markets, a couple of free emerging countries, but really, maybe just keep kinda that bucket.
And then, so how would. And I want to get back to the cap weighted as well. We'll come in this part. How would somebody implement this strategy? You mentioned, what 10 different countries there. So you just go and find those funds. What do you do to say, oh, I'm going to put a hundred thousand of my portfolio, into this strategy.[:
So pick the cheaper one first, so go to Franklin Templeton and see if you can find the their country specific fund if they don't have it because they don't have all of them, then you can go to ice shares and I shares has a more expensive version. But still has that country specific fund when all said and done the effective expense ratio of all of them put together is somewhere between .
Point two, two, or 0.29. So this is 29 basis points. Or 22 basis points. So it's a little bit more expensive than your vanilla. Like I bought this for nine basis points, but when you're going for that 2% annual advantage, it nets out to a gain. So you start by picking up those funds and which ones you want to do you in our criteria, we found that it didn't help to Eliminate too many more funds.
And it also doesn't help to add very many more funds. So we did try two other strategies in the back testing that we didn't officially write in the article, but when I was doing it, I found that tightening it up and picking less didn't produce a better return and Whiting in it more didn't produce a better return so that I think the set of countries that we have is the best.
You don't have to agree with me though. If there's a country you don't like, and you want to try. It's your portfolio and it's your money. So you could try dropping one out. But then we do a cap weight. So we do that based on, you can look up the like footsy developed. We'll tell you what all the percentages of all the countries are.
For example, you could look up something as simple as that, to see what the weightings are, and then use those to discern how much you're going to play in each of those country buckets. if all that sounds really laborious and you're like, I don't want to do any of that.
We have a modified version of freedom investing that we put out for free as part of our gone fishing portfolios, which is on our website. So you can always start there and be like, what percentages did they say here? And we do slightly less countries in there because we're trying to keep it really tight in the number of ETFs that are in the list.
Or if you're like,, I want the whole strategy. And I don't want to do it myself. We have the freedom investing is implemented at every level of our investment management. You can sign up for our S our lowest one is called, do it yourself, which is you do all the financial planning and we'll do the investing for you.
And it's only 0.4% a year. So it's down there with, the other kind of cheap investment management companies.[:
[00:21:27] Megan: we actually have two different ways that we do the do it yourself. So one of them we have for people who like a robo. We have a Schwab intelligent portfolio, which is a robo side. And some people just really like that. And we have that. We also actually hand trade the accounts for people. So if they want, they can get this, the normal, like you have an advisor they're trading your account for you and you can talk and we're going to meet your withdrawal needs and whatnot by hand.
And so we implement things like tax loss, harvesting a little bit that way too, in a way that the robot. Yeah, it does Textless harvesting, but it also just like wildly realizes gains. And I don't know if I like that too. So again, there's probably more words than people want to read because we have a pro con list for the two so that you can help decide which one you want.[:
And we said it before the show, was telling Megan, investments are. Everything we're talking about today. Whereas taxes are fact. I can tell you, you just fill out the form. Here's how much you're paying. And when you get a trade, but the robo does for you to rebalance in a year when you have high income already, then Yeah.
You're paying, 10, 20, $30,000 in taxes and capital gains. Whereas you could have spread that out over a couple of years and paid a lot more.[:
[00:22:56] Mike: Anyway, a note on robo-advisors go back and listen to that episode. So I got it on the implementing. We've got, how many different countries, it was like 10 countries, Megan, and the full list.[:
[00:23:07] Mike: Okay. Somewhere about 10 countries and you can find them a couple places. Megan said, Franklin Templeton, or I shares you can find those specific funds. And then you just
go ahead. And if you want to look, there's different levels, like she said about it you could just do it yourself.
You can do the full thing and go cap weighted and look that up. You could just say, oh, I'll do seven of the, I like these seven countries. I'll just equal weight those seven countries and invest in, in some of those and do it that way. The. Couple of hundred of ways to implement it. Whatever works for you.[:
So if you want to save some time, I realized now you could just. Just to go over to cheat off of our sheet and see what the tickers are that we've got there.[:
People are coming out with new products all the time. So it's Hey, this one looks a little better now we're gonna switch over, save everybody some dollars. Which is fantastic.[:
[00:24:41] Mike: Yup. Yup. That's awesome. Anything else that we dimensioned the emerging markets a little bit. We didn't get too much into it, but there it's harder to find the freer emerging markets. There's again, there's a couple of articles. What are the countries? Chile and Taiwan are the two that you tilt towards.[:
So that's, again, a lot of the emerging markets fall in that area. I don't think there's a ton of reason of picking the best of the worst. We haven't found that advantage. So this freedom investing doesn't hold true. If you just pick up two countries and you're like, I'll invest in this one because it has a higher score.
If they're both under 50, you're not going to, I don't think you're going to see an advantage. It's not something that you can apply. Just picking up any two countries. It really seems to be, there's an environment that facilitates an advantage. And if they have that free environment, then it's great. I think the analogy might be something like it'd be like trying to predict which students in school are going to do better based on well, this kid, he doesn't.
For three days, but the other kid, he doesn't eat for two days. So maybe the kid who doesn't eat for two days, we'll perform better, but it's like both of them are starving. So you want a scenario where like your corporations are not starving. You can't predict,[:
Index the IEF index all, everything, their cap weighted score. Have you ever looked at that? What the cap weighted freedom score would be of your free, the way you implement it versus a cap weighted freedom score for how just develop markets in terms of market cap and what that would be.[:
You can find articles on our website that are about those countries specifically and why they're not doing as well as the other ones.[:
[00:27:33] Megan: definitely think that's true. Cause there's some in the UFC that have a score of, 60 year or high fifties. Whereas the ones that we're picking by definition are all higher than 75. So[:
[00:27:46] Megan: yeah.[:
You can go to them, runaway wealth management, look at their different levels, do it yourself, or different levels of getting your help. Is there anything else that we haven't covered in terms of freedom investing?[:
[00:28:17] Mike: That's pretty good.[:
[00:28:18] Mike: good. Listen, I love it.[:
I'd be, I'd love to write an article.[:
[00:28:44] Megan: So the website is Marotta on money.com. Some Marotta is M a R O T T a and then on money.com. And as we've mentioned before, we've got a newsletter, there are newsletters free. It just sends out the latest copies of our articles, which are also free. So you can get that delivered to you each week and read that we have a lot of different types of content on there.
So freedom investing is one. But we do a lot of articles about tax planning or other aspects of portfolio of management. And it's just a wide range, 5 29. There's a tons of topics on there. I think right now our blog is talking about health insurance subsidies this week and how to take advantage of those.
So anyways, if you subscribe, you'll be able to get all that different wealth of knowledge. We pride ourselves on not having a secret sauce. We just tell everybody exactly how to make all of the best things that we do. And we do so much that we feel like we can still bring a ton of value. So after reading all of the stuff that we do, if you're like, I don't want to do that, but I'm totally convinced we have our services.
And if you're like, I do want to do that myself power to you, read the articles and do it all. I think it'll really help your finances.[:
So definitely go and subscribe. And thank you so much, Megan, for tuning us into this idea of freedom investing. I think it's a fantastic strategy. And as I said, I've been personally implemented it for quite a while. And I love the idea and so really appreciate you coming on and sharing that with all of our listeners today[:
[00:30:29] Mike: Thanks for joining us on financial planning for entrepreneurs. If you like, what you heard, please subscribe to and rate the podcast on Apple iTunes, Google play Spotify, or wherever you get your podcasts. You can connect with me on linkedin or mortonfinancialadvice.com. I'd love to get your feedback. If you have a comment or question, please email me at email@example.com. Until next time thanks for tuning in