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This year I started studying a bit of finance to understand better personal investments. One of the most popular general advice for US based investors is to just buy and hold a low cost ETF fund based on an index like S&P500, which historically has an average return of about 8% (source)

If I want to adopt a similar strategy to invest on European markets, and I look at the historical charts of Euro Stoxx 50 or other European indexes, they are mostly negative or flat. If I assume (which can be wrong) that the future trend will be more or less the same, is there any reason to buy an ETF on these indexes?

I know that ETFs pay dividends. Are these dividends usually included on the overall index performance or must be computed separately?

I think that before choosing an ETF, I should choose an index to be tracked by the ETF. If the dividends are not included in the index performance, how can I understand the actual yield of an index in the long term?

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  • Personally, for my index ETF portfolio, I'd still buy these "flat" index ETFs for global diversification purposes. Historical returns do not necessarily guarantee future returns.
    – Flux
    May 3, 2020 at 9:23
  • You have to look at actual total returns, not just at stock price. The total returns include price increases but also dividends that you could reinvest. Many companies decide to pay out their entire earnings as dividends instead of attempting more growth, which naturally results in a flat stock price. This isn't a bad thing, unless you think dividends are bad (I do, because of tax reasons).
    – amon
    May 4, 2020 at 18:52

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Historical return is not guarantee of future return

If you saw that European indices have returned poorly in the past, you cannot from this deduce they will return poorly in the future.

If stock price goes down, its return goes up, and vice versa

In fact, I would argue European stocks are a good investment because of the following. Let's assume a basket of companies pays $1 dividend. If you need to pay $20 to buy the basket, your dividend yield is 5%. If you need to pay $10 to buy the basket, your dividend yield is 10%. 10% dividend yield is more return than 5%.

Stock prices have a reversion to the mean tendency

Not only is the dividend yield with European companies higher than with United States companies, stock prices tend to revert to mean which causes additional expected return. For example, let's assume that investors generally demand 5% dividend yield but in the European market the dividend yield just happens to be 10%. The basket of companies paying $1 dividend costs $20 in US but $10 in Europe. There is in fact a very good chance that the basket costing $10 in Europe will increase in value more than the basket costing $20 in US. Thus, you get doubly more return: better dividend yield, and better price appreciation.

Conclusion: have an overweight in Europe and underweight in US

There is no crystal ball to say whether European stocks yield more or less in a given time interval than US stocks. However, European stocks have a better chance of yielding more. Thus, I would suggest you to buy more European stocks than most investors buy, and less US stocks than most investors buy.

Why not buy only European stocks, then? Because of diversification. For example, US markets have more consumer products and technology companies, whereas European markets have more industrial and financial companies. By buying only European stocks, you will have very serious underweight in the consumer products and technology sectors. So I'm not suggesting to buy only European stocks. I'm suggesting to have a slight overweight in Europe and a slight underweight in US.

Additionally: Prefer STOXX 600 to Euro STOXX 50

You want to have as good diversification as possible. The Euro STOXX 50 invests to only 50 large companies, and if I'm not mistaken, only in the Eurozone. Why would you want to limit yourself to only 50 large companies and to only Eurozone?

STOXX 600 in contrast invests to 600 companies so you will get exposure to smaller companies as well, and also invests to European companies not in the Eurozone.

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    Thanks a lot for your answer. Can you please explain better "If stock price goes down, its return goes up, and vice versa"? Where can I find historical data about yields for various indexes? It's not so easy to find as their price. Thanks again!
    – martjno
    May 3, 2020 at 15:15
  • Basic mathematics. If you get 1 USD dividend, with 10 USD price it yields 10% but with 20 USD price it yields only 5%. Thus, the smaller the price is, the greater the yield.
    – juhist
    May 3, 2020 at 15:34
  • multpl.com/shiller-pe -- I use this site for historical data. According to it, US stocks are rather overvalued now, but then again alternative investments such as bonds yield only little, so perhaps that might explain the apparent overvaluation. The huge bubble today is not in stocks; it is in bonds.
    – juhist
    May 3, 2020 at 15:35
  • That is clear, but if I want to compare the yield of an index with another, that is already normalized on its price. For what regards the site, the link you provided gives mostly US data. I was looking for some source where I can easily see historical price and yield (or the total return index) of the main international indexes. Thanks again.
    – martjno
    May 4, 2020 at 5:30
  • As presented, your "reversal to mean" argument is just an example of the gambler's fallacy. I've lost so many times, now it's almost certain that I'm finally going to win! No. The probabilities/beliefs should be unchanged. If anything the historical data supports the belief that Euro stocks are a worse investment – even though past performance is not a predictor. If you want to overweigh EU, please not for pseudo-mathematical arguments but e.g. due to beliefs that EU is better positioned to prosper in a post-Corona or post-Climate-Crisis environment.
    – amon
    May 4, 2020 at 15:42

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