For the most part, investors are a greedy bunch. In the race to find undervalued stocks and outperform the market, typically no stone is left unturned. But surprisingly, there is a huge segment of the market that most investors overlook entirely when building their investment portfolio. And it's not an obscure corner of the market, like timber or nuclear power. It's one of the largest and most important areas of the entire stock market.
A recent study by London-based asset-management firm Schroders suggests that although most American investors think the sun will soon set on U.S. economic dominance, they are reluctant to invest abroad. In fact, only 13% of individual investors responded that they own any foreign stocks at all. And only 19% say they expect to own foreign stocks within the next five years! That means a huge majority of investors won't own any of the terrific overseas companies that will help fuel global economic growth. Although more of the survey respondents believed that China would be the next global superpower (45%) than the U.S. (38%), investors are still hesitant to invest outside their borders.
This news is somewhat surprising, and it highlights a disconnect between investor beliefs and investor actions. Obviously, investors are aware of the importance of international investing, even though many have not yet acted on this information. However, this news does show one potential area of growth for money managers and mutual funds in the coming years. If more individual investors get the message that international investing is important, the industry could see increased demand for products that allow access to overseas markets.
So why do so few investors venture into foreign investment waters? No doubt much of the reluctance comes from a lack of comfort and knowledge of foreign markets. But by passing over this segment of the market, investors are only hurting themselves. More than half of the total global stock-market capitalization lies outside U.S. borders. So by investing only domestically, you would be overlooking roughly half of available investment opportunities!
Additionally, foreign markets can provide additional sources of return if the domestic economy falters. It's true that global markets are more highly correlated now than they were 15 or 20 years ago, but they still offer important diversification benefits. Wouldn't you rather have exposure to 10 or 12 foreign countries rather than hang all of your hopes on the domestic market? In today's economy, if you are an intermediate- to long-term investor, it just doesn't make sense not to invest in foreign companies. And five to 10 years from now, this will be even more true, so if you have hesitated to take that international plunge, start looking now.
The best approach
If you are new to foreign investing, the easiest way to dip your toes into this arena is through a diversified foreign mutual fund or exchange-traded fund. Stay away from country-specific funds and ETFs, which are too narrowly focused and can be extremely volatile. Investors are much better off sticking to broad-market diversified funds. If you are in the market for a foreign ETF, check out offerings such as the iShares MSCI EAFE Index Fund (NYSE: EFA ) , the Vanguard FTSE All-World Ex-US Fund (AMEX: VEU ) , or the SPDR S&P World Ex-US Fund (AMEX: GWL ) . If you choose an actively managed foreign fund, look for one that invests in both developed and emerging foreign economies. This way, you can get all of your required foreign exposure in one easy step.
One word of caution for international investors: Foreign markets have done extremely well the past few years, and there is a good chance that a lot of the upside has already been priced into foreign stocks. While it makes sense for investors to always have at least some international exposure, be aware that returns in this area of the market may not be as impressive as they have been in recent history. But don't make the mistake that 80% of individual investors are making by avoiding foreign stocks. Think globally, and you'll already be further ahead than most investors will ever be.