The Closest Thing to a Free Lunch

Getting some international exposure in your portfolio may be one of the best things you can do as an investor. Why? Because such exposure -- whether through individual stocks, mutual funds, or exchange-traded funds -- generally provides you the same or even higher potential returns but at lower risk.

Burton Malkiel, a Princeton professor, drove this point home for me many years ago in his book A Random Walk Down Wall Street. I never forgot this paragraph, concerning his 21-year research period from 1977 to 1997:

It turns out that the portfolio with the least risk had 24% foreign securities and 76% U.S. securities. Moreover, adding 24% [Europe, Australia, and Far East] stocks to a domestic portfolio also tended to increase the portfolio return. In this sense, international diversification provided the closest thing to a free lunch available in our world securities markets. When higher portfolio returns can be achieved with lower risk by adding international stocks, no individual or portfolio manager should fail to take notice. [Emphasis mine.]

Lunch time
The greater degree of diversification found in international stocks is what provides this free lunch. Different economic conditions, different business cycles, and varying returns in foreign markets provide the diversification -- and the resulting benefit.

I certainly heeded Malkiel's advice and have always maintained a good international presence in my own portfolio. Fortunately, it's not as hard as you might think. Many foreign companies can be found on the NYSE or Nasdaq. Here's a small sample (but not a buy list) to illustrate my point:

If you prefer to stay with a U.S.-based company, you're not out of luck -- just check the financial statements for net sales broken down geographically. American firms eBay (Nasdaq: EBAY) and Cisco Systems (Nasdaq: CSCO) have almost half of their sales recorded overseas.

More reasons
There are many reasons other than diversification to consider international stocks for your portfolio. As Motley Fool Global Gains advisor Bill Mann points out, more than half of the world's market cap lies outside the United States. Many foreign economies are growing at a much faster rate than America's. And since many overseas companies are virtually unknown outside their own region, there are many undervalued opportunities out there.

Nothing is guaranteed, but it's clear we should be looking outside our own borders for the chance to boost returns while reducing risk. If you'd like to see what ideas Bill and his team are tossing around in Global Gains, you can sign up for free access and view their latest recommendations. The service has average returns of 11% since it started in December vs. 5% for identical amounts in the S&P 500. Review the picks and the entire service free of charge for 30 days, with no obligation. Here's more information.

This article was originally published on Dec. 14, 2006. It has been updated.

Rex Moore's portfolio has exposure to such foreign places as China, Europe, and New Jersey. Of the companies mentioned in this article, he owns shares of eBay, which is a Motley Fool Stock Advisor recommendation. Shanda Interactive is a Rule Breakers selection. The Fool has a disclosure policy.