Investing theory holds that adding international stocks to a portfolio dampens the odds that a tanking U.S. market will wipe out your fortune. When your domestic stocks go down, those international stocks can still go up.
A 21st-century investor has to wonder whether that's still true. Don't financial markets move in tandem in this global economy? Haven't mammoth multinational companies blurred the line between domestic and international investing? Is the world round, flat, or some kind of wacky polygon?
Enter Karen K. Lewis, a finance professor at the Wharton School of Business, who decided to test the diversification power of international stocks.
She found that U.S. and international stocks do show an increased tendency to move along the same pattern, but that tendency has increased only slightly over the last 20 years, and not as much as your observation of the markets might suggest. At the same time, she found, foreign markets have become less volatile themselves.
Both trends make international investing an attractive way to reduce risk in your portfolio, which Lewis said can be achieved by putting 20% of your money into foreign markets.
Going global
That's a smaller proportion than the recommendation made by another Wharton professor, Jeremy Siegel, who suggests investors put as much as 40% of their capital abroad. The point remains the same. Diversifying your portfolio by adding an international flavor reduces your risks by spreading your money among different kinds of investments.
Where can you go to find international opportunities? Lewis' research suggests that you can get the most bang for your buck by buying foreign stocks traded on foreign exchanges. One easy way for the average investor to do that is by finding a top-notch mutual fund that invests in foreign stocks.
For instance, the T. Rowe Price Global Stock Fund has parlayed investments in America Movil (NYSE: AMX), Petroleo Brasileiro (NYSE: PBR), and Rio Tinto (NYSE: RTP) into an average gain of more than 22% annually over the past five years.
Index funds or exchange-traded funds offer another easy way for American investors to capture the performance of international markets in their own portfolios.
You can buy the world via investments like the Vanguard FTSE All-World ex-US ETF (AMEX: VEU), which tracks the performance of stocks everywhere in the world except the United States. If you're seeking a smaller sliver of the international pie, you can find very specialized investments. For instance, funds like the SPDR Emerging Middle East & Africa ETF (AMEX: GAF) focus on relatively untapped areas of the international markets.
Whatever route you choose, start looking abroad for opportunities to spread your wealth, lower your risk, and better weather the ups and downs at home.
For more international ideas, find out:
- How to profit from the world's growing middle class;
- Another reason you must own international stocks; and
- The easy way to invest internationally.
