The Biggest Threat to Your Portfolio Today

CBS flew me to New York and put me up in a tony midtown hotel the other day so I could appear on The Early Show. The topic? What investors can do to cope with this economic "fiasco" -- Harry Smith's word, not mine.

During the pre-interview, Smith asked me point-blank, "Tim, where is the safest place for our money?" I told him that while it depends on your timeline, if this truly is money that you don't need for the next 10 years or more, then the safest place is foreign stocks.

He shot me a look and said, "I'm going to challenge you on that."

Never happened
Television being what it is, he never did get around to challenging that assertion. (I've never yet been part of a segment that didn't get cut short.) I wish he had.

Take China, for example. Though its growth is slowing, it's still expected to grow from 7% to 9% per year for the next decade. This is why Princeton economist Burton Malkiel wrote in his most recent book on investing that "the biggest risk to any investor's portfolio today is not to have at least some exposure to China."

But an even bigger risk -- nay, threat -- is that you don't have any exposure to any other countries at all!

Here's why
Most Americans are dramatically underexposed to foreign markets. While there's no consensus as to how much foreign exposure the average American has, estimates range from 2% (dangerously low) to 20% (slightly low). This has two significant consequences.

First, it leaves you especially vulnerable to a slowing U.S. economy. Today, for example, as you're watching the value of your home drop, you're seeing your stock portfolio decline and your hard-earned dollar buy less and less. Even worse, given our weakening economy, your job prospects may be dimmer than they were this time last year. We've heard horror stories this month from Wachovia (NYSE: WB  ) employees who had most of their retirement monies invested in company stock.

Second, when you ignore foreign markets, you're all but assuring that you are going to miss out on the greatest economic growth of the next 10 to 15 years. Given development trends, I believe China, India, and Brazil all stand to outgrow the U.S going forward by significant margins. Other emerging countries such as Vietnam, Indonesia, Colombia, Mexico, Thailand, the Philippines, and Poland also have that potential, though their futures are a bit harder to predict given additional political and economic uncertainty.

The good news is you can buy exposure to all of these countries in your portfolio, thus increasing returns and reducing volatility in the process.

How much is enough?
I'm not the only crazed investment analyst who's advocating that American investors take advantage of current volatility to beef up their exposure to promising international stocks.

Earlier this month, Ibbotson Associates recommended that American investors should invest 35% of their portfolios abroad, with at least a third of that allocation devoted to the emerging markets. Citigroup one-upped that plan when the advisor told its clients recently to up their international exposure to 55%. And one of the smartest investors around, PIMCO co-CEO Mohamed El-Erian, told Money magazine, "The world of tomorrow suggests a much greater exposure overseas. ... [Y]ou should consider holding a third of your equities in the U.S., a third in industrial countries outside the U.S., and a third in emerging markets."

Add that up and El-Erian believes American investors should devote a hearty 66% of their portfolios to foreign stocks!

Which brings us to ...
The good news is that if you've been reading along and now find yourself convinced that you're underexposed to foreign stocks, this is a good time to make it right. Foreign stock markets -- and particularly the emerging markets -- have suffered this year as slowing growth has led investors to abandon shares that were previously trading at very premium valuations.

And today, for example, some of China's fastest-growing names have not only seen their valuations come down, but also their spreads narrow relative to their slower-growing American peers:

Chinese Company

January 2008 P/E

Recent P/E

U.S. Peer

January 2008 P/E

Recent P/E

ChinaMobile (NYSE: CHL  )

31.8

13.0

AT&T (NYSE: T  )

19.9

12.5

Baidu.com (Nasdaq: BIDU

147.3

67.7

Google (Nasdaq: GOOG  )

47.8

22.4

Ctrip.com (Nasdaq: CTRP  )

85.4

36.0

Expedia (Nasdaq: EXPE  )

28.1

13.2

Data from Capital IQ, a division of Standard & Poor's.

While growth abroad is slowing, it is certainly not stopping, and the valuations on emerging stocks today give you a much better chance of making money that they did just 12 months ago.

To recap
By now you should know:

  1. You need foreign stocks in your portfolio.
  2. You don't have enough of them.
  3. Now is a good time to buy them.

You can, of course, gain exposure to foreign markets through a host of low-cost ETFs and mutual funds. But if you're looking for the best of the best, try our Motley Fool Global Gains investment service -- free for 30 days. We recommend two new stocks every month, as well as our best bets for new money now. Just click here to get started -- there's no obligation to subscribe.

Tim Hanson does not own shares of any company mentioned. Baidu.com and Google are Motley Fool Rule Breakers recommendations. Ctrip.com is a Hidden Gems pick. The Fool's disclosure policy recommends you garnish your gin & tonic with a sprig of basil rather than a slice of lime. It really is quite a refreshing combination.


Read/Post Comments (7) | Recommend This Article (30)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 02, 2008, at 6:08 PM, FOOLBEFREE wrote:

    Tim,

    Great article. I have been buying BIDU latelly and already owned CTRP. I also have EDU, GSI, KHD, PBR, RIO, CX, and other foreign stocks.

    -> Having a percent on good foreign companies is a wise idea.

    Thank you for the reminder.

    In 6-12 months when the world economy starts growing again, foreign stocks will outperform, and we will see multi-baggers in a few years.

  • Report this Comment On October 02, 2008, at 8:11 PM, bobcollins wrote:

    Always appreciate the info...what about the McDonalds, Pepsi, GE, and other American companies that get significant portions of their income from abroad?

  • Report this Comment On October 02, 2008, at 8:27 PM, kayakmastr wrote:

    Great commentary! Right on target!

  • Report this Comment On October 10, 2008, at 6:33 PM, rwk2008 wrote:

    Hello? The overseas markets have been dropping as fast, or faster, than the US markets. Someone who had 50 or 60% in those markets likely has seen a greater drop than those with mostly US, unless the US stocks were heavily in financial and auto-makers.

    Try this - pick stocks that will do well in a long recession. Discount stores, soup makers, whatever.

  • Report this Comment On October 11, 2008, at 8:23 AM, gbroyal wrote:

    I thought I saw a Financial Sunami on the way two months ago, I cashed in all of my portfolio and deposited the money in a fund which is ring fenced for saftey at 5.25%.

    Meanwhile theportfolio has gone down 25% and being out of the market I, may miss some specticular gains when the turnround comes, I feel though that as a percentage I will be ahead of the game when I reinvest in the same stocks. I like the way you do your stockpics and believe they are the best I hav used. I will continue to follow your advice, but later.

    gbroyal

  • Report this Comment On October 12, 2008, at 1:29 PM, yarkant wrote:

    Does it matter that Chinese companies do not "play by the rules"? violate human rights, cheat foreign investors (I lost nearly 1 million), do not fully disclose, do not enforce international laws they have agreed to (IP, etc). .....is there a point where we draw a line? Or have we? Whatever pays.

    I do not write from a vacuum with 20 years of experience in China business. Westerns seem to wine a lot about human rights but when push comes to shove....we just can not resist.

  • Report this Comment On October 12, 2008, at 4:32 PM, bigbroslittlebro wrote:

    When Jethro got a bad deal from his bank, Goober suggested "Throw a rock through the window" Although the window was shatterproof, still, how is an American going to throw a rock through a foreign window? Support America or give in to the internationalists(correction - Globalists). America is being burned by some really smart people, they are not making "stupid mistakes", it is deliberate. They did not make that HUGE bailout bill overnight. They could not even read it overnight. Think, study, investigate. Boom, bust, Expansion, contraction. Wealth is not being lost, it is being redistributed.

    Remember the talks about a Shadow Government? George Bush Sr. Saying "we will now have a new world order.

    Point is... I want some market advise that includes how to handle how I can survive when my country is dying. When I have to rent from a foreign owner of American soil.

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