For many investors, the notion of taking their stock portfolios across the pond is intimidating at best. Between currency fluctuations, political uncertainty and unfamiliar accounting standards, it’s easy to see why.
A growing body of evidence, however, suggests exposure to foreign stocks can deliver some important diversification benefits to an otherwise U.S.-centric portfolio, helping to offset Wall Street volatility and distribute risk over multiple economies.
Consider the iShares MSCI EAFE, an exchange-traded fund, or ETF, that closely tracks the Morgan Stanley Capital International, or MSCI, EAFE Index, a stock market index of 21 developed markets including Europe, Australia and the Far East.
Its three-year annualized performance as of July 2014 was close to 8 percent, and more than 10 percent over five years. Meanwhile, the Standard & Poor’s 500 index ETF SPY returned more than 16 percent over the past three years and more than 17 percent over the past five years. That might seem to argue against investing overseas, but there are times when foreign stocks outshine those in the U.S., and diversifying among asset classes helps keep volatility down.
John Thompson, partner and head of investment solutions at Hewitt EnnisKnupp, recommends investors earmark 25 percent to 30 percent of their total equity portfolio to global stocks.
That figure drops to 20 percent or less as investors reach retirement age, he notes.
Tips for going global
Perhaps the easiest way to invest in foreign stocks, says Thompson, is to purchase mutual funds or ETFs that mimic the MSCI EAFE.
Target-date funds or life-cycle funds are another option. Such funds invest in a mix of stocks and bonds based on the investor’s time horizon, and many automatically include a 20 percent or greater foreign weighting.
“Target funds are very good tools for people who don’t want to work closely with their money and want to leave that responsibility to a third party,” says Thompson.
There are also, of course, American Depositary Receipts.
ADRs are stocks that trade in the U.S., but represent shares in a foreign corporation.
U.S. banks simply purchase a specified number of shares from the company, bundle them into groups and reissue them to investors.
There’s no need to convert currencies since the stock trades in U.S. dollars.
Issuing companies must comply with SEC requirements and abide by U.S. accounting standards.
Risk of emerging markets
Due to inflation risks and heightened volatility, Thompson suggests average investors steer clear of emerging markets altogether — or be prepared for a bumpy ride.
“Emerging markets are not meant for conservative investors,” he warns.
For an example of the volatility: The SPDR S&P Emerging Markets ETF returned more than 14 percent in the 12 months through July 2014, but over three years, it eked out a gain of less than 1 percent.
Check your holdings
When it comes to international investing, bear in mind that as global economies become increasingly intertwined, the line separating domestic and foreign stocks is fast disappearing.
Many multinational U.S. corporations that investors hold in their retirement accounts, for example, derive a significant portion of their annual revenue from overseas markets.
And unbeknownst to most investors, domestic large-cap mutual funds also frequently include a small percentage of foreign stocks in their holdings.
Chances are, you already have more exposure to international stocks than you think.