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US investors will often ask themselves if investing in international stocks is worth the trouble.
Warren Buffet has constantly advocated that you should “always bet on America.” He’s often discouraged the common investor from buying international stocks. However, the man has made some foreign investments of his own.
Another predominant investor, Jack Bogle, has made it very clear that he is against investing in international equities. He said in an interview with Morningstar that “I do not think you need to add international.” And that he holds 0% in non-US securities.
So why should you consider buying foreign stocks? Some of the greatest investors are telling you not to do it. Yet there are some benefits of investing in international stocks.
We’ll go over the reasons why along with some of the cons that are involved.
Why You Should Invest in International Stocks
Global Growth Potential
The US market is much more mature and grown compared to foreign emerging markets. Having exposure to more youthful economies such as Brazil, India, China, South Africa, and Russia allows for higher upside potential.
The economies are still developing in many countries outside of the US. International stocks provide opportunities to take part in future long-term growth. Expect lower growth prospects for developed countries compared to emerging markets.
The middle class and overall consumption rates are growing at a faster rate outside of the US. By not having any exposure to foreign securities, you miss out on a lot of impending growth.
The American stock market and international stock markets do not move in tandem with each other. Allocating a portion of your investment portfolio in international stocks reduces risk and improves returns.
Rebalancing your portfolio between the two investments as they move in different directions has shown to increase performance.
Riding the ups and downs of only the US market is essentially putting all your eggs in one basket. It’s harder to have a well-diversified portfolio that doesn’t include any foreign securities.
If you want to minimize your risk and diversify your portfolio, then you’ll likely want to include some allocation in foreign investments. US stocks are typically less risky, but not when they’re the only thing you are invested in.
The performance of global markets is cyclical. By investing in only one market, you are increasing your risk.
Higher Dividend Yields
Dividend investing is a great way to lower risk and retain passive income. Foreign equities tend to produce higher yields compared to their US counterparts.
Returns are plummeting on US Treasuries, and the S&P produces less than a 2% yield (at the time of this writing). Investors need to be creative and take on a bit more risk to obtain a decent dividend.
International stocks provide another avenue to get higher dividend yields for your portfolio.
The Cons of Investing in International Stocks
When comparing international index funds to US index funds and ETFs, you’ll notice higher expense ratios. Most global market funds come with an increased cost of ownership.
Higher expense ratios can take a chunk out of your returns. The difference between international funds and US funds is mostly insignificant, but they’re still higher.
- The Schwab U.S Large-Cap ETF (SCHX) has an expense ratio of 0.03%
- The Schwab International Equity ETF (SCHF) has an expense ratio of 0.06%
It’s also worth noting that at the time of this writing, the dividend yield of SCHF is almost double that of SCHX.
You can see the slightly higher costs aren’t very much to fret about. It can be more drastic with other funds. Generally, this is still a valid con for investing in international stocks.
There is a higher risk involved in investing in global markets compared to the US. If you do not properly optimize your portfolio or hold too many foreign equities, you are increasing your risk.
While underdeveloped economies have higher growth potential, they also include increased risk. There can be potential political problems, monetary issues, and more.
Many international companies are not held to the same financial reporting standards as the US.
Less transparency can lead to possible accounting fraud and company scandals.
Taxes, Complexity, and Underperformance
Investing in individual foreign securities can involve higher tax implications. The US offers a “foreign tax credit” to help minimize your liability and prevent double taxation. The foreign taxes paid must be qualified to receive the credit.
Adding a position in international stocks requires more research on your end. You will need to understand another investment, which creates more work for you.
US stocks have outperformed international stocks for longer than a decade.
Historically though, the performance between the two is cyclical. This may indicate international stocks could start to surpass US equities soon.
Keep in mind that past performance doesn’t guarantee future results. In recent years US stocks have produced significantly higher returns.
How Much of Your Portfolio Should Be in International Stocks?
The general rule of thumb is that you should have 15-20% of your portfolio in non-US stocks.
20% seems to be the overall best allocation amount, but everyone will have their own preference.
Remember, a larger percentage of foreign equities can potentially increase your risk.
Be sure to invest only an amount that you are comfortable with. And most importantly, understand what you are investing in.
Best International Stock ETFs
Investing in international ETFs is a simple and effective way to obtain global exposure. ETFs can minimize your risk and improve your diversification.
Picking individual stocks involves more risk and work. Especially when picking individual international stocks.
Some of my favorite international ETFs to invest in are:
- Schwab International Equity ETF (SCHF) – A good choice for a core holding in a long-term portfolio. The ETF has broad diversification with large and mid-cap stocks from developed countries outside of the US.
- iShares MSCI Emerging Markets ETF (EEM) – This highly traded ETF offers the perfect exposure to emerging markets and developing economies. Due to its high trading volume and available options contracts, it is better suited for short-term trading. EEM’s higher expense ratio makes VWO a better choice for long-term investing.
- Vanguard FTSE Developed Markets ETF (VEA) – If you are looking for only developed markets and mainly large-cap exposure, VEA is a good choice.
- iShares MSCI EAFE Small-Cap ETF (SCZ) – Many international ETFs primarily track large-cap companies. SCZ offers investors the ability to invest in small-cap stocks. Adding small-cap exposure can better diversify your portfolio.
- Vanguard International High Dividend ETF (VYMI) – This ETF is broadly diversified and focused on dividend producing stocks from non-US companies.
The case against foreign investments is valid, but overall, the benefits make it worth investing in international stocks.
The main pro is that you can diversify your portfolio and still get excellent returns. The key is to avoid over-diversification and over-concentration.
The US market has generally always been the leader. However, that doesn’t mean you should avoid investing in other countries.
Don’t think of yourself as betting against America. Think of it as betting on the world along with America.