We live in a global economy. This is as true for investing as it is for commerce. Over two-thirds of the market value of stocks worldwide comes from companies outside the borders of the United States. What does this mean for you as an investor? That’s simple: opportunities for investing abroad are plentiful and should be considered. If you truly want to diversify your investment portfolio, it should contain some stocks and/or bonds issued by companies overseas.
Below are three reasons to invest internationally:
• For Opportunity- Restricting investment dollars to U.S. securities alone eliminates many of the world’s top-performing markets. Many innovative products and services are being developed by overseas companies.
• For Diversification- Not always, but often (especially beyond short-term time periods), foreign markets “zig” when U.S. markets “zag.” In other words, they follow different economic cycles and are affected by different factors (e.g., country-specific events and currency fluctuations). This increases portfolio diversification and reduces investment risk.
• For Protection- Overseas and multinational (e.g., Coca Cola) companies derive a substantial portion of their earnings from sales abroad and generally do well when the U.S. dollar is weak against other currencies.
Let’s say you’re now convinced to add some international stocks to your portfolio. How do you do it? For most people making their first international investment, mutual funds are best. Below is a description of six types of mutual funds that many people use to add international exposure to their investment portfolio:
• International Mutual Funds- International funds hold foreign company securities only. No U.S.-based companies are included. Many investors select them to compliment the U.S. securities (e.g., a Standard & Poor’s 500 index fund) that they hold, thereby increasing portfolio diversification.
• Global Mutual Funds- Global funds hold securities from companies worldwide. In other words, they include both foreign and U.S. company securities. A global fund’s prospectus will describe the relative proportion of domestic and overseas investments.
• Regional Mutual Funds- Regional funds invest in a specific area of the world such as the continents of Europe and Asia.
• Emerging Markets Mutual Funds- Emerging markets funds invest in companies of countries that are developing their economies through rapid industrial expansion, especially through manufacturing.
• Single-Country Mutual Funds- Single-country funds focus on just one foreign nation such as Russia or Japan.
• International Index Funds- International index funds track a benchmark index of world stock markets. A commonly-used index is the EAFE index which measures the performance of large company stocks worldwide. Funds that track the EAFE index often have the words “total international index fund” in their title. There are also regional index funds that track indices for specific regions or continents. Two advantages of international index funds are broad diversification and low expenses.
International diversification is more apparent over longer time frames than during a short-term financial crisis when all stock markets worldwide are volatile. The more narrow a mutual fund’s focus (e.g., regional, emerging markets, and single-country funds versus global and international funds), the more volatile it tends to be (less diversification) and the more sensitive to currency fluctuations and political unrest.
