Should you invest internationally?
Investment and Asset Management
Diversification is one of the most effective strategies for optimizing performance and reducing risk. Yet the average U.S. investor’s stock portfolio allocates 90% to domestic securities. Given that U.S. equities usually account for around half of the global equity market, investors who ignore international markets may be missing out on a big opportunity to diversify.
Past performance doesn’t guarantee future results and, as with domestic stocks, it’s possible to lose some or all of your original investment in foreign equities. It’s also possible that these stocks will underperform U.S. equities for long stretches of time. However, there are several reasons to consider investing in international stocks:
Potential for improved performance
Because global equities are exposed to a wider variety of economic and market forces, internationally diversified portfolios may perform better. In recent years U.S. stock markets have outperformed non-U.S. markets in the aggregate. But historically, international diversification has led to higher risk-adjusted returns, according to Fidelity Investments.
One effective strategy for reducing risk is to invest in assets that aren’t perfectly — or are negatively — correlated. The prices of highly correlated assets generally move in the same direction at the same time. When assets are negatively correlated, they usually move in opposite directions. Investing in combinations of assets that aren’t as correlated — such as U.S. stocks and international stocks — tends to reduce risk.
Investing in multinationals may not be sufficient
In today’s increasingly global business environment, it’s tempting to conclude that investing in U.S. multinational companies provides sufficient international exposure. But studies conducted by Vanguard and Fidelity Investments show that stock in multinational companies, despite their significant overseas operations, tend to be highly correlated to the U.S. stock market as a whole. Thus, they may not offer the same diversification benefits as international stocks.
Every investor is different, and there’s no one right international allocation. Aggressive investors may try to enhance returns by allocating more than 30% of their portfolios to international stocks. But many other investors, particularly if they need the money relatively soon, may feel more comfortable allocating less to international securities.
It’s important to discuss international stock exposure with your financial advisor. Your advisor can help you arrive at an appropriate allocation based on your goals, risk tolerance, investment time horizon and personal circumstances. Understand that diversification doesn’t guarantee profits or protect against losses in a declining market.
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