Four Reasons to Invest Internationally

Chances are, right now you are surrounded by things that were invented, assembled, or grown outside the United States. We've become very accustomed to buying goods from other countries. There's no reason why we shouldn't also purchase investments from outside the U.S., as well. In fact, there are plenty of arguments for how you'll be wealthier for doing so. Here are four of them.

1. It's a big world out there.
While the U.S. stock market is the largest in the world, it still makes up less than half of the $24.2 trillion value of all the stocks in the world, as of the end of 2010. Here's how the global stock market breaks down:

Country% of World Stock Market Capitalization
United States

49%

Japan

10%

Other Pacific

6%

United Kingdom

10%

Other Europe

19%

Canada

5%

Source: Ibbotson Stocks, Bonds, Bills, and Inflation Yearbook

Investors who restrict their portfolios to U.S. stocks are literally missing out on a world of opportunity.

2. The U.S. is not always number one.
The following table shows the average annualized returns of stocks from various parts of the world from 1970 to 2010, broken up by decade and the entire period:

1970s1980s1990s2000s1970-2010
Canada

11.0

11.7

9.9

9.2

10.7

Europe

8.6

18.5

14.5

2.4

10.7

Pacific

14.8

26.4

0.5

-0.3

10.0

EAFE*

10.1

22.8

7.3

1.6

10.1

World

7.0

19.9

12.0

0.2

9.6

U.S.

5.9

17.6

18.2

-0.9

10.0

*MSCI Europe, Australasia, and Far East Index. Source: Ibbotson Stocks, Bonds, Bills, and Inflation Yearbook

As you can see, the long-term returns for each region over the entire four-decade period are similar, but the returns are quite different from decade to decade. In only the 1990s was the U.S. stock market the leader, and it was the worst-performing stock market in two of the decades (the 1970s and 2000s). In other words, there's no compelling historical argument for ignoring international investments.

3. The value of diversification
When assets have similar long-term returns but dissimilar shorter-term returns, holding a mix of these investments can produce more money than the individual parts on their own. For an illustration, check out how much $1,000 turned into when invested in Pacific stocks, U.S. stocks, and European stocks, as well as a global portfolio made up of equal parts of the aforementioned three categories.

Portfolio (1970-2010)$1,000 Turned Into…
Pacific Stocks

$49,378

U.S. Stocks

$49,655

European Stocks

$63,906

Global Stocks

$65,307

Source: Ibbotson Stocks, Bonds, Bills, and Inflation Yearbook

The whole exceeded the sum of its parts, and it didn't require investors to predict which region would come out on top. Yes, correlations among the world's stock markets have gone up over the past decade, but that doesn't mean U.S. stocks and international stocks perform identically each year. This is because the return of an international stock to U.S. investors is due to two factors: 1) the price performance of the stock, and 2) the changes in value between the currency of the stock's home country and the U.S. dollar. This makes international investing a hedge against a falling greenback. And because currencies change in value relative to each other on a daily basis, there will always be a difference in performance between U.S. stocks and international stocks — and thus a diversification benefit.

4. Not all future innovation will be in America.
In an interview on the Motley Fool Money radio show, Harvard professor Niall Ferguson pointed out that when it comes to originating patents, the top country is Japan, not the United States. South Korea takes third place, and China will unseat Germany as the number four country in a couple of years. Ferguson claims that, by some measures, the U.S. has been in decline since the 1970s. Even if you think that's overly pessimistic, there's no denying that the rest of the world is catching up in terms of economic development and innovation. One way to benefit from that “catching up” is to own international stocks.

The risks of owning international stocks
If you consider volatility as a good measure of risk, then international stocks are more risky than U.S. stocks. But you also have other risks with non-U.S. equities, such as political risk that comes from investing in countries with unstable governments or less respect for property rights. Also, corporate governance and investment exchanges in many countries are not as developed and regulated as in the U.S., leading to a higher potential for manipulation and fraud. Finally, there's the risk that an investment's home currency will fall in relation to the dollar, which would reduce an American investor's returns.

The bottom line
These days, investing overseas seems particularly scary. Every day, the news is filled with stories about Europe's debt troubles, upheaval in the Middle East, and slowing emerging markets. But amidst all the bad news, the Vanguard Total International Stock Index is up almost 12.9% so far in 2012, compared to 9.3% for the S&P 500. You've likely heard that investing when everyone else is pessimistic is a good strategy, and that seems to be the case so far this year. This is not to downplay the risks, which are very real, and the situation can change very quickly. But what won't likely change is the potential rewards that come from owning a diversified, long-term portfolio that contains a healthy dose of international stocks.

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Kraig @ Young, Cheap Living
Kraig @ Young, Cheap Living

I’m 27 and I haven’t yet invested in the stock market but will likely be doing so in the next few years. I have come to agree with you that the best strategy to take when investing is to allocate a percentage of your portfolio to international stocks. You made a lot of good points here. I’m really surprised to see that Europe’s stock has out performed ours from 1970-2010. Interesting..

SB @ One cent at a time
SB @ One cent at a time

Basically countries with higher GDP growth rate than US, mostly has outperforming stock market compared to US.

I have some exposure to global stocks through mutual funds, but its amazing that the earnings are lower than their domestic counter part. Strange but true.

BlueCollarWorkman
BlueCollarWorkman

My sister is a scientist and has spoken several times with me about how the US isn’t as “on top” as it used to be. While funding for research in the US has been being pulled over the past decade, funding in other growing countries has not. ANd the results have been clear and obvious–other countries are surpassing us in innovations and research. You no longer MUST come to the US to get a worthwhile degree, there’s lots of other great countries you can go to to get a great scientific degree. I had never thought about this in regards… Read more »

David
David

I work in research science as well, and this is so true, and so sad. I wish policy/budget makers were able to look further ahead than the next election when it comes to investing in the future of the U.S. Basic research is a boon to the economy, but it’s a long-term investment. Instead, we get moronic YouCut style ideas trying to cut NSF spending even more! FYI, the NSF budget last year was around 7 billion, which is about 0.2% of the entire US federal budget. Really?! This is where we should focus our efforts to “trim the fat”?… Read more »

BrentABQ
BrentABQ

“Look up something called Amdahl’s Law.” I really wish the people running the show understood basic engineering and information science concepts. For the layman Amdahl’s law is about how much improvement you can get by only changing a part of a system. If you cut the nsf budget (.02% of total) by 50%, you can only get a .01% improvement.

Back on topic: I purchased a emerging markets index fund a couple years ago and it hasn’t done stellar, but it hasn’t been very poor either. I think its good to keep things spread around anyways.

Kris
Kris

I have to admit I truly enjoy reading Robert’s articles. Anymore, Robert and JD are the only ones who post anything I can really relate to. I started reading this site nearly five years ago and have enjoyed following JD’s growth into financial maturity as well as my own. Now I feel that the only real value I get from this site is from these two authors. I guess I’m looking for more posts that explain how to invest and manage money as I continue to financially mature (CD ladders, Dividend Investing, Muni Bonds, Taxable account investing etc…). While I’m… Read more »

Tyler Karaszewski
Tyler Karaszewski

You are far from the only one to express dissatisfaction that J.D. doesn’t write as much around here as he used to. The thing about “personal finance” writing is that the “finance” part of it is pretty much trivial and if you’ve been reading it for more than a week, you’ve already heard everything. The “personal” part of it can be interesting though, and that’s why we all miss J.D. We enjoy his story. None of the other authors on this site have a story (quick – what’s April’s husband’s name? Is she even married? You don’t know cause there’s… Read more »

Kris
Kris

Tyler, I think you hit the nail on the head. Maybe it’s time to move on to a few more sites that focus on my individual needs. I don’t think I’ll ever be able to completely walk away from GRS but it has definately taken a different turn over the last 6-12 months. In my opinion this is, by far, one of the best blogs out there for learning the fundamentals of personal finance. I wouldn’t hesitate for a second to recommend this site to someone trying to get their financial life in order. For that, I will always be… Read more »

El Nerdo
El Nerdo

lol her husband’s name is luis– if you read her articles you’d know this 😛

but you make a good point that GRS needs to become a multicharacter novel, sort of like Balzac’s oeuvre, rather than an arctic explorer’s journal. right now it’s probably stuck in magazine mode. still a good magazine though.

SmartMoneyHelp
SmartMoneyHelp

Good points.

I have had success with allocations of pacific and emerging market indexes in my portfolio. It has provided for a nice steady increase when non-international markets have been down.

There are a lot of good indexes out there to choose from. One thing that I watched out for was transaction costs and expense ratios.

PFM
PFM

I’ve used a general rule of thumb to have 10% invested in a foreign index fund, there are some years I cringe at the returns but realize diversification has helped my overall portfolio grow.

Megan
Megan

Very good post, and it’s definitely food for thought.

@Kris (#3) – I see what you mean, but I like that GRS is a mix of topics and writers under the rather nebulous umbrella of “personal finance.” The investing articles are great to read, but I also like posts on how to cut costs at the grocery store. Yesterday’s post on class was insightful as well.

It’s this eclectic approach that keeps me returning to GRS!

Kristen
Kristen

…and was a post written by J.D., as I recall… which is exactly the point. It’s the story- the narrative- that brings many of us back every day.

Mo
Mo

One note. The people who actually do this successfully are people who are already paying expensive lawyers to do their taxes. A friend listened to someone about investing overseas, did so, and ended up selling out, taking a loss when the cost of paying tax attorneys in two countries was figured in.

Robert Brokamp
Robert Brokamp

I think you are referring to something more complicated than what I’m suggesting in this post. Perhaps your friend invested in foreign real estate or businesses? I’m suggesting that people buying publicly traded stocks or funds that invest in them. This doesn’t require a lawyer (though there are tax consequences, as with all stock investments).

Mo
Mo

No. My friend bought stock in a foreign company, publicly traded on that country’s stock market. It ended up making his tax return far more complicated, enough that all his (small) returns on the investment were eaten up by the professional tax preparation he now required. He followed exactly the sort of hand-wavy, sounds good advice you are giving that turned into a real mess. “I’m suggesting that people buying publicly traded stocks or funds that invest in them. ” Did you read your post or was there some part of it that got edited out before you posted? What… Read more »

Robert Brokamp
Robert Brokamp

Perhaps I should have included a paragraph on how to invest in international stocks. The easiest way is through mutual funds or exchange-traded funds that invest in such stocks (such as the Vanguard fund I mentioned in the article, or its ETF equivalent). Chances are, such a fund is a choice in your employer-sponsored retirement account (though, as some commenters have suggested, it may not be the best or cheapest option). I can assure you that such funds do not require the services of an attorney or an accountant. Another method is through American Depositary Receipts (ADRs), which are essentially… Read more »

Tyler Karaszewski
Tyler Karaszewski

I own a developing markets fund that I purchased through my 401k with no special requirements. It’s just like owning any other mutual fund.

Ivy
Ivy

For those who enjoy investment discussions the Boggleheads forum is terrific. I think JD posted about it recently as well, but here is the link. It’s fun to read the discussion threads http://www.bogleheads.org/forum/index.php We have close to 40% of our portfolio in international index funds. I am a believer in diversification and I actually think the typical advice doesn’t take it far enough. The usual advice, including on the forum above, is having 20% or so international. But you are already exposed to US volatility in much broader sense than your investments. You probably work for an US company, you… Read more »

Nicole
Nicole

I use EFA, which tracks MSCI EAFE. How is it doing? Not so great, but we haven’t had international for very long so I imagine it will balance out eventually.

Adam P
Adam P

Unfortunately, for most of us contributing to retirement through work with matching, the international fund choices are parlous and carry higher than normal fees. I don’t have any access to emerging markets and (in Canada) I have yet to work for a company that carried a simple S&P500 index fund, just funds that try to match it but charge 1% or so to do it and track it poorly. This is good advice for those trying to invest outside of an employer provided plan tho. My self directed discount brokerage account I have 20% to international and 20% to emerging… Read more »

Nicole
Nicole

All my international and emerging market stuff is in my IRA accounts (the US option for outside of work retirement savings), not the employer accounts. You’re definitely right that it’s hard to find reasonably priced diversification choices with most limited employer choices.

frugalportland
frugalportland

Soon (after my debts are paid) I’d like to start investing in something other than an IRA. How much money does one need to initially invest in an index fund?

Tyler Karaszewski
Tyler Karaszewski

I’m not sure you understand how your IRA works. You can invest in an index fund via your IRA. Look at the investment options your IRA offers, they likely include at least one index fund.

TheWizard
TheWizard

One thing to point out it isn’t like it use to be though. American companies (General Electric for example) are now much more diversified and invested globally now compared to 20 years ago. Essentially when you invest in a US fund/company you are also investing internationally now as well.

rubin pham
rubin pham

japan is no 1, south korea no 3 and china no 4 on the list of countries with the most innovations. yet many american still believe that the chinese steal american technologies and thus destroying american economy. this attitude perfectly illustrate the image of american as arrogant fools.

El Nerdo
El Nerdo

nice rant, though little informative.

since you’re an expert in these areas thought, can i ask you how you weigh japanese government debt when assessing japanese stocks? how is japan coping with debt repayment? how high are taxes, and what kind of burden does this place on companies? i guess this is all irrelevant when you look at the P/E ratio, but i like to understand the mechanism behind my statistics.

I Am 1 Percent
I Am 1 Percent

Good advice…keeping your money in US investment vehicles is akin to putting your eggs in 1 basket. Diversification is important, and the major growth is occuring in emerging markets.

Krantcents
Krantcents

I invest internationally as part of my asset allocation. The US is no longer a safe haven and in many cases performs worse than some other countries or regions in the world.

Marianne
Marianne

We have just begun to invest and our (tiny) portfolio is about 75% Canadian and the rest divided between the States and Europe. We’ll see how that works for us. I feel very comfortable with it!

mike
mike

Momma always said don’t put your eggs in one basket.

I say when one of your basket falls and you crack a couple eggs, take some eggs from your bigger baskets and put into the lower basket.

Ru
Ru

Is there a Get Rich Slowly post on where to start in the stock market? I’m from the UK and just want to start some basic investing because my savings are making nothing. I don’t have much money to invest, we’re talking about £300 here. Can you start with such a small amount? I don’t know where to begin at all.

Sara
Sara

Hi Ru, here’s a post by JD from about six months ago (“Ask the Readers: How Do I Get Started with Investing?”) and the Money 101 website he often refers to:
https://www.getrichslowly.org/ask-the-readers-how-do-i-get-started-with-investing/
http://money.cnn.com/magazines/moneymag/money101/

GregL
GregL

I’d totally recommend the Motley Fool UK Investment guide – it may be a little old now but the advice is clear and easy to understand.
http://www.amazon.co.uk/Motley-Fool-UK-Investment-Guide/dp/0752219014
Based on this book I started up a Legal and General UK Index Tracker ISA and have been very happy with the results.

Joe
Joe

Canada may look like a great performer. But keep in mind: (1) the TSX is extremely heavily laden with resource producers (particularly oil/gas) so it’s correlated with commodities and (2) our P/E ratios are terrible compared to the best American stocks.

whoisbiggles
whoisbiggles

It would be interesting to see how the various international indexed fund products performed vis a vis the various international indexes returns listed above.

Money Infant
Money Infant

With the US accounting for less than 30% of the worlds GDP can you afford not to invest globally? There are many great companies overseas and chances are when we are in recession in the US the economies of other countries are doing quite well. From 2003 to 2007 the MSCI Emerging Markets Index had better performance than most other world indexes averaging just about 38% increase per year.

Brendan Ross
Brendan Ross

International stocks are risky. All equity investing is risky. However, U.S. investors are probably mistakenly overconfident about the relative prospects of the U.S. market relative to other markets. Behavioral finance studies have found that a common error among investors is to confuse the familiar with the safe. U.S. investors are more familiar with U.S. equities than foreign equities and thus assume they are safer. The same phenomenon can be seen throughout the world.

Plex
Plex

Oh, how sneaky, noting that Japan is 10% of the world’s market capitalization, but then, when going over returns combining it with the much smaller (and much more successful) Pacific market to hide Japan’s terrible 40-year market return history. This helps make the International market look much more stable than it actually is, Japan is the clear example used when showing how low the deviation can get for International stocks over a 40 year period. Just in case you are curious, the Nikkei index has LOST money in the just under 30 years it has been tracked. If you look… Read more »

Cristao
Cristao

I’m 27 and I haven’t yet invested in the stock market but will likely be doing so in the next few years. I have come to agree with you that the best strategy to take when investing is to allocate a percentage of your portfolio to international stocks. You made a lot of good points here. I’m really surprised to see that Europe’s stock has out performed ours from 1970-2010. Interesting..

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