Holding foreign stocks is a necessary part of a balanced portfolio. Many investors know this is true, and they use international mutual funds to gain exposure to the global markets. Indeed, the U.S. international mutual fund market hovers around $300 billion.
That's great, but some investors are simply paying way too much to go global.
According to The Vanguard Group, the average international mutual fund charges a 1.68% expense ratio, and some, like Oppenheimer Developing Markets A (ODMAX), charge front-end sales loads on top of 12b-1 fees.
Using the Oppenheimer Developing Markets A as an example, assuming a $10,000 initial investment and 10% annual returns over the next 10 years, you could expect to pay approximately $4,771 in total costs (i.e., fees, loads, opportunity costs) over the next decade.
That's almost half of your original investment. Ouch.
That's a big chunk
"OK," you might ask, "but what if the Oppenheimer fund outperforms the market? Wouldn't that make the extra costs worthwhile?"
Absolutely. But the Oppenheimer fund would have to return roughly 12% per year just to break even with the index-tracking Vanguard Total International Stock Index Fund (VGTSX) returning 10% under the same scenario.
And considering that 75% of active funds fail to outperform their benchmarks over the long haul, you'd have to be pretty confident in your fund manager's stock-picking ability to be willing to throw almost half of your original investment behind him or her.
Here's a better way
Rather than spending inordinate amounts of time researching expensive fund managers in a quest to outperform the market, I follow the "core and explore" school of investing -- that is, invest the majority of your portfolio in index-tracking funds (build a core) and supplement them with a few great stocks you think will beat the market (explore).
Apparently, the smart money has been doing just that. According to a 2006 Wall StreetJournal article, managers of the 200 largest pension plans increased their holdings of index funds from 16.7% in 1995 to 26.8% in 2005. One manager interviewed in the article cautioned against overpaying for market returns, noting, "For your market exposure, you might as well use the most efficient vehicles possible." Those vehicles include no-load mutual funds and low-cost index-tracking ETFs.
So instead of paying $4,771 to the Oppenheimer fund, you could pay just $793 over 10 years by investing in the Vanguard Total International Stock Index -- with a fraction of the manager risk. The Vanguard fund holds what you might expect of an total international fund -- everything from developed-market juggernauts BP
Now that you have assets diversified across the international sector, the extra $3,900 or so you'd save by choosing the index fund can be better spent finding individual stocks you think will outperform the market. So, for example, if you're bullish on the Chinese communication industry, you might consider adding Qiao Xing Universal Telephone
Foolish bottom line
For the money you'd be paying a fund manager to beat the market, I'll posit that you have a better chance beating the market on your own -- and for a lot less money, too. Even if you find five good stocks and pay a $15 commission to buy each of them, that's only $75 in up-front costs -- much less than the $575 you might pay on a $10,000 investment in a fund with a 5.75% front-end sales load.
Finding such quality stocks, however, takes a little extra time and effort on your part. This is especially true in the international realm, where extra currency, political, and national risks are an inherent part of the game.
If you need some help navigating the international waters, consider a 30-day free trial to Motley Fool Global Gains, our brand-new international investing service. It not only gives you two new substantiated stock ideas each month, but also teaches you what to look for in superior international stocks.
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