By Megan E. Corcoran
The recent volatility in the U.S. stock market probably has you thinking of ways to diversify your portfolio–so why not let your money take a trip overseas? International investments are a great way to expand your portfolio and get the diversity you need to weather most economic storms.
“No one region gets all the excess returns over long time periods,” says Chris Wolfe, global equity strategist at J.P. Morgan. “History points to the wisdom of international diversification, so it’s smart to take advantage of various political and geographical spheres, because if you are only investing in the U.S. you are only availing yourself to one set of opportunities.”
Wolfe illustrates his point by comparing market index performances over past decades–Japan’s compound annual growth rate was 9.3% in the 70’s, compared to a meager 0.3% in Europe and a sluggish 2.4% for the Standard & Poor 500 in the United States; and in the 80’s, Japan and Europe outperformed the U.S. with compounded annual growth rates of 20.8% and 15.3% respectively, compared to the S&P 500’s 12% growth rate. Furthermore, according to Morgan Stanley Capital International, the U.S. market has been among the world’s top five performers in only four of the past 20 years.
But Wolfe stresses that geographic diversification isn’t effective if it’s concentrated in one industry, since an industry correction can be global in scope–witness the technology sector’s recent worldwide dive. “It’s important to have sector diversification, as well as international diversification,” says Wolfe, and it’s important to invest long-term, at least five years, to realize significant benefits.
Luckily, right now globalization, deregulation, and technology are creating tremendous investing opportunities in the strengthening economies of Eastern and Central Europe, Russia, Latin America, India and China, as well as the growing markets in Europe and Japan.
“There’s a whole world of opportunities outside the U.S. and some very important long term trends emerging that will create some significant investment opportunities for the years to come,” says Henrik Strabo, chief investment officer of international equities at American Century World Mutual Funds. His International Growth Fund (TWIEX) has returned 52.8% over the past year and 27.7% over the past three years, although it’s down 6.2% year-to-date.
“There are powerful long term trends taking place in non-U.S. markets that have already occurred in the U.S.,” says Strabo. Managers are increasingly being paid based on performance and profitability, and they own equity through stock options, so management’s interests are more aligned with investors’ interests. Moreover, the creation of the Euro-currency is expanding the European market and allowing European companies to compete with the rest of the world from a larger base. And entrepreneurship is mushrooming outside the United States.
If you agree that it makes sense to put your money to work overseas, the next question is what investment vehicle to use. You have a couple of options, but the best and easiest way to invest overseas is through mutual funds. Mutual funds are much simpler to buy than individual non-U.S. stocks and don’t have the added nuisance of currency fluctuations and obscure tax ramifications. And since investing in other countries requires access to information about the local markets, you really need the professional investment advice and local market expertise that mutual fund managers provide.
You could pick individual stocks, but it’s difficult to research non-U.S. companies because of different reporting and accounting standards, currency issues, and a whole host of other variables that investors aren’t used to dealing with in the U.S., says fund manager Strabo. “I get out and travel and meet with companies to kick the tires,” he notes.
There are global, international, and regional mutual funds that allow investors to target a specific region or type of company; and there are index funds that give investors a finger in every pot. Whichever method of investing you choose, a well-diversified portfolio should have anywhere from 10%-25% foreign holdings, depending on your risk tolerance. So, once you decide what percentage of your portfolio should be overseas, identify which markets appeal to you and then invest consistently until you reach your allocation goal.