The Most Overlooked Investment Opportunity

For the most part, investors are a greedy bunch. In the race to find undervalued stocks and outperform the market, they typically leave no stone unturned. But surprisingly, most investors entirely overlook one huge market sector 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.

Missed opportunities
A 2007 study by London-based asset-management firm Schroders suggested that although many American investors are far from convinced that the U.S. will continue to dominate the world economy, they are still reluctant to invest abroad. In fact, only 13% of individual investors responded that they own any foreign stocks at all, while only 19% said they expected to own foreign stocks within the next five years. Since then, of course, the bear market has pummeled stocks around the world, both foreign and domestic.

If the results hold true, a huge majority of investors won't own any of the terrific foreign 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%), many 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.

Global investing
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 like the iShares MSCI EAFE Index Fund (EFA). Just look at some of the companies it invests in:

Company

Share of Assets

HSBC (NYSE: HBC  )

1.96%

BP (NYSE: BP  )

1.80%

Nestle

1.73%

Banco Santander (NYSE: STD  )

1.35%

Total (NYSE: TOT  )

1.30%

Source: Morningstar.

If you decide to go with an actively managed fund instead, you may be able to find one fund to serve multiple purposes. For instance, the Vanguard Global Equity (VHGEX) fund invests not only in foreign stocks, but also in companies like Pfizer (NYSE: PFE  ) , State Street (NYSE: STT  ) , and IBM (NYSE: IBM  ) that have international scope.

One word of caution for international investors: Foreign companies are just as vulnerable to bear markets as U.S. stocks are. While it makes sense for investors to always have at least some international exposure, returns in this area of the market may not be as impressive as they were during the previous bull market.

Nevertheless, you shouldn't make the mistake that 80% of individual investors are making by avoiding foreign stocks entirely. Think globally, and you'll already be further ahead than most investors will ever be.

There's a lot of confusion about international investing. Let Paul Elliott show you what you may have wrong about investing your money overseas.

This article was originally published on Aug. 28, 2007. It has been updated by Dan Caplinger, who doesn't own shares of the companies mentioned in this article. Pfizer is a Motley Fool Inside Value recommendation. Total is a Motley Fool Income Investor pick. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy has many stamps in its passport.


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