When investing for the long term, it's usually a good idea to get some exposure to economies other than that of the United States. One of the best ways to do this is with global stock funds, which can provide great exposure to foreign economies without the challenge of picking individual stocks, or even individual countries, to invest in.
What is a global stock fund? And what separates the best global stock funds from the rest?
What are global stock funds, and why should you invest in them?
First, it's important to note that "international" and "global" stock funds are not the same thing. International funds invest virtually all of their assets outside of the United States. Global funds, on the other hand, can invest in both foreign and domestic companies in order to create diversified exposure to economies around the world.
Investing in global funds has several advantages, the biggest of which is diversification. Global stock funds allow you to spread your money across not only many companies, but many sectors, geographical locations, and foreign currencies. So the health of your investment isn't too dependent on any single country's economy or any single currency. Global funds also have the potential for higher returns associated with foreign stocks and the risk mitigation of domestic investments.
In a nutshell, global stock funds are a way to produce solid growth while hedging against the U.S. dollar, eurozone weakness, emerging-markets performance, and pretty much any other economic issue, all at the same time.
What makes a fund better than the others?
Basically, there are two things you need to look at when deciding on a mutual fund or exchange-traded fund to invest in: cost and performance.
The first characteristic of great funds is a low expense ratio -- that's the percentage of the fund's assets that go toward management expenses every year. This is pretty easy information to find, as it is generally included in a fund's prospectus and is included with most quotes.
Performance is easy enough to find out -- but for the best results, think long-term. In other words, don't worry too much about how well a fund has performed year to date; it's five- or 10-year performance is likely a much better indicator. These funds should be bought as solid long-term investments, not as short-term trades.
Some good examples to look into
There are a few good ones out there, so choose a fund with low expenses and solid performance that you feel is the best fit for your portfolio. One good example is the Vanguard Total World Stock ETF (NYSEMKT:VT). It has an extremely low 0.18% expense ratio, which is 86% lower than the average for funds with similar holdings. And the fund has averaged 10.2% returns during the past five years.
One potential drawback is too much domestic exposure for people really looking to diversify, as more than 54% of the fund's holdings are located in North America.
Another good example is the iShares MSCI All Country World Minimum Volatility ETF (NYSEMKT:ACWV), which, as the name implies, looks to invest in companies with relatively low volatility. The fund has a rather low 0.34% expense ratio, and its top holdings include such well-known stalwarts as Johnson & Johnson, Verizon, and General Mills. No single company makes up more than 1.53% of the fund's total assets. Although the fund is just three years old, it has averaged an 11.2% annual return since inception.
These are just two examples, and there are plenty of other good funds out there as well.
How much of your portfolio should be in foreign stocks?
This is a tough question, and there's not one right or wrong answer. First of all, different global stock funds have different levels of exposure to foreign markets, so make sure you know exactly what you're buying with the fund you choose.
It also depends on your personal risk tolerance and your thoughts about certain global issues. As a general rule, people who are willing to take on more risk in exchange for higher potential returns can afford to have more exposure to foreign stocks. If you think, for example, that the U.S. is headed toward rapid inflation, you may want higher foreign exposure to hedge your portfolio against the U.S. Dollar.
The bottom line is that the actual amount of global exposure you need in your portfolio is a personal decision. However, most investors should have some level of exposure to non-U.S. markets. Funds like the ones mentioned here are good ways to get it while still being able to sleep at night.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.