International Investing Advantages

Do you have enough international stocks in your portfolio? If not, you may feel like you've missed the boat on big profits.

By nearly every measure, stock markets in foreign countries have been going nuts for several years running. Hit hard by the U.S. bear market from 2000 to 2002, world stock markets, as measured by the MSCI EAFE index, have since risen at a faster pace even than stocks here at home. Over the past five years, the index has returned roughly 15% annually. Compare that to the S&P 500, which has risen less than 6% annually since 2003.

Fear and greed
With such strong past performance, you'd expect average investors to jump on the international bandwagon. And you'd be right -- mutual fund flows favor international stocks over domestic.

Yet just as the rise of real estate investment trusts (REITs) in the late '90s finally gave way to a correction during 2007 and 2008, international stocks have been slowing down. China's Shanghai index, for example, has taken quite a beating in 2008, after years of building hefty valuations. This has caused fundamentally sound companies like PetroChina (NYSE: PTR), China Mobile (NYSE: CHL), and American Oriental Bioengineering (NYSE: AOB) to all plummet more than 20% so far this year

In addition, the softening of the domestic economy has sent waves of fear rippling around the world. Yet that doesn't mean the Shanghai index and other international markets won't rebound to new highs -- or at least resume their upward motion. Like a game of musical chairs, you don't want to be the last one to buy into soaring international stocks before a major correction occurs, but you also don't want to be the last to recognize when it's time to get back in the game.

Is 10% enough?
Traditionally, many financial advisors recommended that investors keep most of their stock investments within the U.S., typically allocating just 10% or so to foreign stocks. Planners argue that lower levels of investing regulation, less transparent financial disclosure, and political and economic instability support a conservative approach to allocating money to foreign markets.

However, just as REITs have benefited from planners' increasing willingness to divert some of a client's fixed-income allocation away from bonds, advisors are now taking a second look at the 10% rule for international stocks. As the global economy continues to evolve, national identity among corporations becomes less important every year. Perhaps the most obvious example is the automotive industry, where Japanese manufacturers like Toyota (NYSE: TM) and Honda (NYSE: HMC) have built plants in Kentucky and Indiana, while American makers Ford (NYSE: F) and General Motors (NYSE: GM) maintain manufacturing plants around the world. Given that the U.S. economy makes up only about a quarter of the world's gross economic product, ratcheting up international stock allocations even an additional 5%-10% makes plenty of sense -- yet it could also have a huge impact on stock valuations going forward.

It's true that even if you only own American stocks, you still have a wide exposure to the worldwide economy. However, just as diversifying across sectors of the economy is prudent to avoid risks to specific types of companies, diversifying across national borders can give you some protection against an economic downturn that hits a particular country.

International investing advantages
One other objection many investors have is that learning about companies across the world can be more difficult than researching U.S. companies. The nuances and subtle differences in the way people do business around the world require analysts to think outside the box when judging how well a company might be able to perform in the global marketplace.

The Fool started its international investing newsletter, Global Gains, in part to help shed more light on investing opportunities available overseas. But it's not just a stock-picking service. Along with monthly recommendations, you also get informative commentary about particular industries, general economic conditions, and business practices in different regions of the world. Global Gains can give you the comfort you need to expand your investing horizon beyond America's shores.

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This article was originally published on July 3, 2007. It has been updated.

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This article has been updated by Kristin Graham and was originally written by Dan Caplinger. Kristin does not own shares in any of the companies mentioned in this article. American Oriental Bioengineering is a Motley Fool Hidden Gems recommendation. The Fool's disclosure policy is good everywhere you want to go.

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