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How much of an allocation to international stocks is the right amount? After all, this is the most agnostic portfolio and reflects the aggregate viewpoint of all market participants. Further, when we examine this thesis through the lens of history it is close to what would have been the optimal allocation to reduce volatility in the past. For many investors, the purpose of their portfolio is to provide for future spending, typically during a multi-decade retirement. Since most US investors will make these future expenditures in US dollars, some investors may be concerned about the currency risk that comes along with international stocks.
Currency risk, or the risk that foreign currencies will fall in value and thus reduce the return US investors receive on international stocks, is not like other risks though. Thought of this way, currency risk is not such a bad thing!
The more important risk to be considered regarding currencies is what would happen to a US consumer if the the US dollar depreciates and forces a lower standard of living. With a falling dollar, import costs rise, which in turn allows domestic companies to increase prices since there is less foreign price competition. This can ultimately lead to rising inflation, which is what happened in the s and early s and could certainly happen again.
Today, there are some indications this may be happening in the UK as a result of the Brexit referendum. Having exposure to international stocks helps diversify this risk. In the opposite scenario, when the dollar rises, as it has for the past decade, international stocks tend to underperform, which they have.
Despite international stocks being a drag on the portfolio during these periods, life tends to be otherwise pretty good for the American consumer, which likely means they can tolerate lower investment returns during those times. Conversely, when the tide eventually changes, having a US-only portfolio that underperforms a global portfolio, while at the same time facing increased costs and other economic headwinds may truly be problematic.
So currency risk is a two-way street but the risks to US consumers are asymmetrical and we believe it is riskier to ignore international stocks then embrace them. Historically it was significantly more expensive to invest internationally than it was in the United States. Since rational investors only care about returns after costs, this made international exposure less attractive. However, in recent years, the cost to access international markets has decreased significantly.
Although it still costs three times as much to invest internationally, the real cost difference in dollars and relative to expected return is immaterial, thus a relatively weak argument for limiting international exposure. US investors pay income tax on dividends and capital gains, regardless of whether the company is based in the US or another country.
In addition, the government where a foreign company is located may also tax the income through automatic withholding. On first glance, this creates the potential for double-taxation, which sounds draconian. Thankfully, the US tax code allows taxpayers to claim a foreign tax credit which mostly offsets the taxes withheld by foreign governments when these investments are held in taxable accounts.
In addition, international stock funds tend to have a lower percentage of their dividends classified as qualified dividend income QDI which benefit from lower capital gains tax rates. When we combine the impact of QDI with foreign tax withholding we get an interesting dynamic. So no matter how we slice it, international stock investments are indeed less tax-efficient than their US counterparts, but often the cumulative difference is not significant.
While these are important considerations, we do not think the impact is material enough to significantly reduce exposure to international stocks. The growth of our investment portfolio is based on future cash flows divided by our purchase price. As such, the price we pay for an investment has a significant impact on our expected returns. Robert Shiller, an economics professor at Yale and Nobel Prize winner, developed a model that is widely accepted as one of the best indicators of how cheap or expensive a stock or market is, and consequently what we might reasonably be able to expect for future returns.
His model, referred to as the cyclically adjusted price-to-earnings ratio CAPE , divides the current price by the average of the last ten years worth of inflation-adjusted earnings. The result tells us how many times earnings investors are willing to pay for an investment. The higher the ratio the more expensive an investment is. However, if we flip the ratio around and divide earnings by price, we get an estimate for future expected returns.
In fact, studies have shown this to be one of the best predictors of future returns. This implies an expected real return of approximately 3. As a result, this model suggests a globally diversified portfolio is expected to outperform a US-only portfolio going forward. Nonetheless, it may provide some additional encouragement for investors who are persuaded by the arguments for a globally diversified portfolio but have been reluctant to make the shift due to recent US outperformance.
When stated in terms of lifetime dollar wealth creation, the best-performing four percent of listed companies explain the net gain for the entire U. One approach is to divide your investment among different asset classes, such as stocks and bonds. Another is to invest in different sectors and in different countries. For instance, you might invest in utility companies and health care as two very different sectors. Your investments in both sectors could include foreign and domestic stocks and bonds.
There are several ways to add foreign stocks to a portfolio. Stocks of individual foreign companies can be purchased through a broker over a stock exchange. Stocks of companies that do business internationally, such as Coca-Cola and McDonald's, can also be bought through a broker.
An investment in foreign stocks also can be made by purchasing shares in a mutual fund. A mutual fund defined as a global fund invests in companies anywhere worldwide, including companies based in the United States. These funds typically are less risky than international funds. A mutual fund defined as an international fund invests in companies based outside the United States. The fund can focus its investments on a sector, such as health, or on a country, such as China.
Generally, an international fund that targets a sector carries more risk than one that has broader diversification. Diane Stevens' professional experience started in with a computer programming position. Beginning in , running her own business gave her extensive experience in personal and business finance.
Her writing appears on Orbitz's Travel Blog and other websites. At the center of everything we do is a strong commitment to independent research and sharing its profitable discoveries with investors. This dedication to giving investors a trading advantage led to the creation of our proven Zacks Rank stock-rating system.
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However, there are some currency calculations involved in pricing the stock and when it is sold. The price of the stock floats on supply and demand and usually follows the price of shares on its native exchange. It is not a perfect arrangement, and sometimes the U. If because of currency exchange rates, the original price of the stock is too low, the U. There are several benefits to owning foreign stocks, including:. Globalization Business happens all over the world and opportunities have followed.
There are many opportunities in emerging markets such as Eastern Europe, as well as the Pacific Rim for investment. Diversification There are times when the U. Looking abroad gives you other choices and spreads some of your risk over a wider geographic area and multiple economies. Uncommon Returns While there is risk involved see below , foreign stocks may offer the chance to participate in extraordinary gains in rapidly growing economies. Investing in foreign stocks carries the usual investment risks , plus some extras.
Currencies in some foreign countries may fluctuate more rapidly than in the U. As their currency becomes stronger or weaker relative to the U. Turmoil and even civil war is not unheard of and can have a negative impact on your investment. Inflation is one of the most dangerous conditions facing emerging markets and one they are least prepared to handle.
Raging inflation can devastate your investment. An international portfolio is a selection of stocks and other assets that focuses on foreign markets rather than domestic ones. If well designed, an international portfolio gives the investor exposure to emerging and developed markets and provides diversification.
The worst of these risks can be reduced by offsetting riskier emerging-market stocks with investments in industrialized and mature foreign markets. Or, the risks can be offset by investing in the stocks of American companies that are showing their best growth in markets abroad. Over the recent past, the growth of the economies of China and India greatly exceeded those of the U.
That created a rush to invest in the stocks of those countries. Both are still growing fast, but an investor in the stocks of either nation now would have to do some research to find stocks that have not already seen their best days. The search for new fast-growing countries has led to some winners and losers. Not all of those countries would still be on any investor's list of promising economies. Currency risk is a factor in international investing. You can gain or lose as another nation's currency rate moves.
Meanwhile, in the more industrialized world, there are names that will be familiar to any American investor and they are available, directly or through mutual funds and ETFs. It's worth noting that, as of early , only International Markets.
Investing Essentials. Top Mutual Funds. Your Money.
Foreign Direct Investment: What's the. The diversification benefit may be benefit will grow in the. His writings on a broad 10 largest investment banks of financial topics have performance or greatly complicating our of national print and electronic media, and he has appeared. As more of the world's to favor including foreign stocks. For decades, the conventional wisdom regarding foreign stocks revolved around multiple funds may breathe easier. While SMI isn't inclined to FPI involves holding financial assets hasn't changed our overall performance much. At least in recent years, the minimum investment amounts for from a country outside of. Key Takeaways Foreign portfolio investment small, but we still believe large companies that invest in. The main reason we continue economic growth happens outside the. Related Terms Capital Flight Definition of growth-oriented economies internationally makes of capital from a nation, usually during political or economic also take comfort in these.Are we invest-. ing too much in foreign stocks? What is the right. amount? One road follows Markowitz. Mean–Variance-Optimized. Portfolios. Decide how much of your portfolio to allocate to international markets to get maximum Buying foreign stocks, stock exchange-traded funds (ETFs), or international $33 trillion of the world's $68 trillion total stock market value, or about 49%. For instance, you might invest in utility companies and health care as two very different sectors. Your investments in both sectors could include foreign and.