Many investors only buy U.S.-based stocks or funds because it’s comfortable to stick with the companies we know. But there are good reasons why you should consider broadening your horizons to other developed markets and maybe even emerging markets.
As investment advisor James Duronio of Covenant Capital Advisors points out, U.S. stocks represent roughly half the world’s equity markets. “Investors who only invest in the United States could be missing out on half of the world’s investment opportunities.”
Not just that, but by adding international stocks to the mix you can reduce swings in your portfolio because you’ll be more diversified.
4 Tips For Getting Into the International Stocks Game
Here are four tips for adding international exposure to your investment portfolio.
1. Limit Foreign Investing to One or Two Funds
If you already have investments in U.S. stocks, look for an international or foreign fund instead of a global fund. Global funds usually invest some of their portfolios into domestic stocks, while international funds typically only hold foreign stocks. If you buy a global fund, you may have more of your money in U.S. stocks than you think.
Don’t bother buying too many funds. You won’t see much of a performance difference owning 20 different funds compared to owning one or two carefully chosen ones, but you will have many more funds to monitor. If you’re just starting off, invest in a single fund that follows or tries to beat a broad foreign stock index, such as the FTSE Global All Cap ex US index.
Before you buy any fund, check out the fund’s online fact sheet to learn how they invest.
2. Keep Costs Low
It’s not hard to choose a solid mutual fund, so don’t overpay for advice and services you don’t need.
Funds may deduct sales loads, trade commissions and ongoing management and possibly even marketing charges from the money you invest. Brokers may also layer on transaction fees and even wrap fees. Expensive funds aren’t better than lower cost funds. In fact, the higher the expenses, the lower the returns you’re likely to get. If the total annual expenses of your fund are 1 percent or more, you are probably paying too much. Some international exchange traded funds offered by Vanguard charge as little as one twentieth of 1 percent per year.
Funds come in three broad types: exchange traded funds (ETFs), closed end funds (CEFs) and open ended funds.
- Exchange traded funds are hugely popular with individual and professional investors because of their typically lower cost structure and ease of trading. They are like stocks and trade on an exchange during market hours. Don’t buy an ETF with a “market order” outside of market hours because it might be thinly traded and you might overpay. Wait for the market to open.
- Open end funds are bought and sold once a day through a distributor (usually the fund company) instead of an exchange and are identified with five letter symbols and an X at the end. Some brokers charge for buying and selling open end funds, so make sure you aren’t paying high transaction fees. Some brokers have “no transaction fee” funds. Another potential issue with open end funds is the possibility of trade restrictions. You may not be able to sell your fund for as long as 180 days without getting socked with an early redemption fee.
- Closed end funds are fading in popularity these days. Like exchange traded funds, they trade on exchanges, but have a set number of shares. They also tend to be actively managed. Unlike ETFs and open end funds, closed end funds may trade far above or below the value of the positions they hold.
3. Buy an Index Fund
Did you see an ad for a stock fund with killer performance? Don’t get too excited. Fund managers with great one- or three-year performance reports may simply have been lucky by investing in the right place at the right time. You can’t be sure those results are due to skill.
As of the end of 2020, 75% of international funds studied by S&P Dow Indices underperformed the S&P International 700 index over the prior 10 years. Part of that underperformance is because actively managed funds — funds with managers who try to beat the market — are, on average, five times more expensive than passively managed funds. Those higher costs drag down performance. But even before charges are deducted, two thirds of fund managers still didn’t outperform.
Index funds don’t try to beat the market. Their objective is to match the performance of their benchmark. Because mirroring an index isn’t hard to do, index funds compete on price. They keep costs low, which means that more of your money will be in the markets instead of managers’ pockets.
4. Manage Risks
Investing in foreign markets offers new opportunities and more ways to diversify, but it also comes with new risks.
The two biggest risks of international investing, according to Gerri Walsh, senior vice president of FINRA Investor Education, are geopolitical risk and currency risk. She highlighted the possibility of restrictions being placed on trading in a specific country due to political conflicts.
Currency risk is another. Have you taken any trips overseas? If so, you probably understand currency risk. A sudden change in the dollar’s exchange value can turn a once-underwater investment into a profitable one — and vice versa.
Fund companies classify countries by how risky they are. Developed economies, such as those of the United States, Canada and most of Western Europe, are less risky than so-called emerging economies which aren’t as integrated in global trade.
Russia, India, China, Thailand and Latin America are emerging markets. Some countries, such as Kenya, Vietnam, Uganda and Romania, have markets with thin volumes and lax regulations. These “frontier markets” are best left to specialists.
As you look at fund factsheets, consider how much of the fund is invested in emerging and frontier markets. Funds with more emerging and frontier market stocks will likely be more volatile than funds that only invest in developed markets, but they may also have more upside.
Pros and Cons of Buying International Stocks
We’ve collected the pros and cons of investing in global markets so you can decide if this is a good move for you.
- More diversification
- Increased upsides that show a stock has more value than the price indicates
- It’s interesting to follow global markets
- Foreign funds are usually more expensive
- Emerging and frontier market funds can be very risky
Are International Stocks Right for You?
Owning a good foreign fund with low costs will open your portfolio to new opportunities and lower the risks you have by being only invested in the U.S. But unless you plan to become a foreign policy expert, keep it simple. Find a broadly diversified index fund with low expenses, then simply buy and hold.
Contributor Sam Levine holds Chartered Financial Analyst® and Chartered Market Technician® designations and has written on finance topics since 2003.