As interest rates and inflation rise, that might be the good time to look at the exposure of stocks in your portfolio. There are a range of international funds – both passive index funds that track global markets, as well as actively managed funds – that could be added to the mix.
Because international stocks tend to move independent of US stocks, and because much of the world’s growth lies outside the United States, worldwide investing can provide important portfolio diversification and exposure to other growth opportunities. But that doesn’t mean it is without risk. Investing outside the US entails special risks, and it tends to be more volatile than US investing. Just as you shouldn’t travel outside the country unless you are willing to take on its risks, you shouldn’t invest overseas until you’ve considered and accepted its risks as well.
Diversification
The biggest advantage of foreign stocks is diversification. Purchasing overseas means investing in different countries and sectors, which can offset market volatility – different stocks groups perform better and worse during downturns.
Just as adding a few US stocks will reduce a portfolio’s reliance on foreign countries, adding international stocks means a portfolio will have less exposure to foreign currencies than a portfolio of only US stocks. When International stock funds are priced mainly in currencies other than US dollars, they can dampen the damage a weaker dollar might do to your return back in US dollars.
Owning international stocks gives you better growth potential because you gain exposure to emerging economies and the more established economies around the world that have, on average, faster rates of economic growth than in the US. However, diversification can’t protect you from losses when the stock market goes down (bear market) or guarantee profits, either.
Valuation
Half the world’s market capitalisation is found outside the US. Adding international exposure can give you an additional boost towards diversification and portfolio growth. But it’s important for investors to be aware of the inherent risks of investing overseas – particularly in emerging or developing nations – which could affect your long-term goals and objectives.
Investors might also benefit from market cycles in different parts of the world when extending their international portfolios of stocks. For example, those who already hold stocks globally in the developed markets of Europe and Japan could benefit from undervaluation relative to the US or US markets.
Fidelity research teams, however, are confident that international companies will outperform their US counterparts over time, because consumers in emerging markets across the globe will drive growth and profits for many companies in two decades. What’s more, many international stocks now look cheaply priced.4.
Taxes
Self-directed international investors can most efficiently achieve broad market exposure through global or foreign market index funds or actively managed mutual funds, which provide the quickest and most efficient means of access. They remove the necessity for such investors to invest time and effort in evaluating individual securities.
And for the United States, since many large businesses generate a significant portion of their revenues from overseas sales, many planners advocate including some international stocks in every portfolio.
And that includes political risk: investing overseas means there’s always a chance that a country’s leadership would be hostile towards foreign investments. That would lower returns, and increase volatility, in your portfolio.
One way of doing this is by buying American depository receipts (ADRs) that entitle you to shares in foreign companies but trade in the US. ADRs provide a convenient, cost-effective means of investing in foreign companies without sacrificring geopolitical risks while giving access to assets and industries not widely represented back home.
Risk
Over the long run, international stocks have usually outperformed domestic stocks – often when the foreign economy is growing very fast, as the Chinese or Indian economy has been doing, which can translate into big stock rallies.
Yet investors must remember that any gains could vanish just as quickly when foreign economies falter or political events erupt in another nation. International stocks subject investors to currency risk and liquidity risk as well.
With these risks, you might wonder, why even bother with international stocks? Because of that lower valuation, there is still good reason to consider them for the long-term investor. They have offered somewhat higher than average return over the long haul, and offer a great way to reduce volatility in a portfolio – the lower valuation can really help counter bouts of volatility, and enable your portfolio to zig when others zag. Finally, international stocks might actually position themselves to benefit from an improving world economy better than their domestic counterparts.