My dad always told me that there was no such thing as a free lunch. Nowhere is that more true than in the world of investing.
Do you want to invest in hot growth stocks such as Sirius Satellite Radio (NASDAQ:SIRI) or XM Satellite Radio (NASDAQ:XMSR)? Then you'll need to be prepared to face the risk of losing more than 45% of your investment in just one year. Both stocks lost approximately that amount in 2006.
Would you like to buy shares of a solid dividend payer such as Pfizer (NYSE:PFE)? Then you'll have to accept its minuscule expected average annual growth rate of 4.4% over the next five years.
There is, however, one area of investing that allows you to have your cake and eat it, too (to continue with the food metaphors). That area is international investing. By investing in foreign stocks, you can achieve great returns while you reduce the risk to your portfolio.
According to a leading investment textbook, investing in international stocks can reduce the standard deviation of a domestic portfolio by as much as one-half. Because foreign stocks don't always move in the same direction as domestic stocks, they can provide offsetting gains when domestic stocks lose value. And domestic stocks can provide gains when foreign ones suffer setbacks.
Now, some might suggest that you try to gain your foreign exposure by investing in multinationals such as PepsiCo (NYSE:PEP) or Microsoft (NASDAQ:MSFT), which do a substantial amount of their business in foreign markets. Unfortunately, such a strategy would prevent you from achieving the benefits mentioned above. Those stocks would tend to move in a similar direction to that of the domestic market and would therefore not provide you with the full diversification you need for reducing risk.
The world and everything that's in it
International markets have been a good place to be for investors in recent years. According to a study noted in The Wall Street Journal, 85% of 81 countries surveyed last year experienced gains. During the period from 1996 to 2001, Chinese equities grew at a rate of 651%. Polish equities grew at 287% over the same period. And Peruvian equities soared by 168% just last year!
Now that you know the power-packed potential and diversification benefits of foreign stocks, it's time for a caveat: Finding them poses a number of challenges for ordinary investors. After all, it's one thing to research big multinationals such as BP (NYSE:BP) or Unilever (NYSE:UL), but researching smaller or more regional Polish or Peruvian companies requires an added layer of scrutiny.
If you put in the time, though, it can pay off -- remember, international investing can reduce the standard deviation of a domestic portfolio by as much as one-half.
Our Motley Fool Global Gains service is designed to navigate the choppy waters of the international equity markets. You can see our favorite international stock picks and country-by-country analysis for free with a one-month guest pass. For 30 days, the service is yours for free. Who says you can't have a free lunch?
John Reeves does not own shares in any of the companies mentioned. He lived in London for seven years and still uses words like "telly" and "nappy." Pfizer and Microsoft are Inside Value recommendations. Unilever is an Income Investor pick. XM is a former Rule Breakers pick. The Motley Fool has a disclosure policy.
