Investors are often told that diversification is among the most important things you can focus on. It helps you avoid putting all of your eggs in one basket, which is going to be bad if that basket gets dropped. One key way to diversify your portfolio is to add foreign exposure. Vanguard has a way for you to do that with one simple investment, the Vanguard Total International Stock ETF (VXUS 0.30%). Here's what you need to know.
Diversification is a powerful tool
Think about the S&P 500 (^GSPC -0.39%) for a quick second. It's entirely focused on U.S. listed companies, but it's made up of very large number of stocks, roughly 500 at any given time. Not all of these stocks do well at the same time. For example, right now, there's a small group of large companies, known as the Magnificent Seven, that are doing particularly well. They are driving the broader average higher.
If you wanted to maximize your total returns, you would buy just those seven stocks, which can actually be achieved with the Roundhill Magnificent Seven ETF (MAGS -0.56%). But here's the problem: You would have needed to know in advance that those seven stocks would be the ones to outperform. Unless you have the only crystal ball on Wall Street, which is highly unlikely, picking the stocks that are likely to experience huge gains in any given year is a very difficult task.
By diversifying your portfolio more broadly, you'll increase the possibility of including some of the big winners in your portfolio. You'll also wind up with some losers, but the winners will, hopefully, make up for the losers. That's exactly what the S&P 500 index has achieved for investors who bought the broader index at the start of 2024.
However, this example is still highly focused because it is centered on just one country, the U.S. If you really want to explore the benefits of diversification, you need to think even bigger and include foreign stocks in your portfolio, too.
If you think it's hard to invest in U.S. stocks...
There's a problem with investing in foreign companies. They have to operate within the rules and regulations of the markets from which they hail. It's hard enough keeping up with U.S. rules and regulations -- it would be virtually impossible to also follow the rules and regulations (let alone market dynamics) of a large number of foreign markets. That's why you'll want to consider using an exchange-traded fund (ETF) when you add foreign exposure to your portfolio.
There are any number of ETFs you could use, but the one that probably offers the most diversification in the easiest form is the Vanguard Total International Stock ETF. As its name implies, it basically buys all the stocks that can easily be bought outside of the U.S. It owns nearly 8,600 stocks! You get all of that foreign exposure for a tiny expense ratio of 0.08%.
As the chart above shows, 2024 wasn't exactly the best year for the Vanguard Total International Stock ETF. Remember that it's impossible to predict which stocks, or countries, will be the best performers in any given period. Sure, 2024 was good for U.S. stocks, and the Magnificent Seven in particular. But nobody knows what 2025 will hold. If the U.S. market goes into a tailspin, having exposure to other markets could end up being a huge benefit.
It's the mix that's important
This isn't to suggest that 2025 will be the year that foreign markets outperform the U.S. market. It is merely to point out that you can easily add foreign stocks to your portfolio and materially increase your diversification with one investment, the Vanguard Total International Stock ETF. The goal isn't to jump in with both feet, either. All you need to do is layer in some exposure, targeting maybe 20% to 25% of your stock allocation -- enough so that you are both comfortable with the investment and that it can help to soften the blow if (more likely when) the U.S. market cools off.
