The headlines continually remind us we are part of a global economy.
Just this year, we’ve heard much about the rising cost of oil and the
falling dollar. Our markets are daily affected by news from all corners
of the globe.
Although we operate in a worldwide economy, investor portfolios
seldom reflect a strong international influence. During the 1990s,
international indexes underperformed the S&P 500. Investors got nervous
and brought their money back home. However, as always, the cycle came
back around and investors who pulled out of international funds missed
out on returns higher than those of US indexes. Look at the first
quarter of 2005. The Dow Jones, NASDAQ, Russell 2000 and S&P 500 had
average returns of -4.41%, while the MSCI EAFE International index was down only 1.7%.
Go back 12 months and MSCI EAFE returns were up 15.06% to the average
3.98% gain of the four US indexes.
While most people avoid international stocks as a way to lower their
risk, the truth is that adding international securities, no matter their
risk level, actually lowers overall portfolio risk. The more diversified
a portfolio, the more investment areas available to offset each other,
the lower the risk.
Once you answer the question of why international diversification is
important, however, you’re faced with another: how to do it properly.
There are two common misconceptions. The first is that investing in an
index such as the MSCI EAFE is enough. However, while the EAFE index is
international, it does not represent complete international
diversification and closely follows movement of the S&P 500.
It does not include the small-cap companies or emerging markets
needed for full international diversification.
The second misconception is that stocks of US multinational companies
(especially those with a majority of their business overseas) count as
international diversification. The truth is, these stocks tend to mirror
the markets in their home countries. Colgate-Palmolive, for example,
does up to 80 percent of their business overseas, but their stock price
routinely follows the S&P 500.
All portfolios need proper international diversification.
International funds can lower your overall risk and help balance out
performance of US funds. It’s a big world out there. Make sure your
portfolio reflects it
