Should You Give Your Portfolio a Passport? The Case for Adding International Investments to the Mix
Last December, we gathered our passports and courage and, with three children under the age of ten, boarded an 18-hour flight to South Africa. It was our first major international travel with all three kids. The trip turned out to be fabulous in every respect, but we confess to feeling a fair amount of trepidation in the days leading up to departure. Typhoid shots and malaria pills aside, were we really ready for this adventure?
Perhaps as an investor you've had similar feelings of trepidation when it comes to leaving the comfort zone of what you know. We hear this often when clients wrestle with the idea of international investing. "Oh, that seems so complicated," is a common reaction. Or "I don't want to take on that kind of risk."
We don't discount these concerns. Global investing does add a layer of complexity and risk that, as an informed investor, you must consider. For example, in addition to the normal market movements, fluctuating currency values may amplify the volatility of your investments. Unanticipated political and socioeconomic factors may pose unique risks when investing abroad. And the transaction costs of investing overseas may be higher due to fees and taxes.
Like many observant investors, you've also probably noted that since the 2008 financial crisis and throughout the subsequent recovery, the U.S. stock market has performed remarkably well compared to many other markets. Industry experts are divided as to whether international stocks are likely to pull ahead in the near future. The truth is, no one really knows.
So, given all of this, you might wonder why international investing is worth the bother. But before you give up altogether on the idea of branching out into non-U.S. stocks (or reducing your exposure if you are already holding international stocks), consider what we believe to be the most compelling argument for doing so: DIVERSIFICATION.
You've heard us talk a lot about diversification—the idea that spreading your investments across many industries and asset classes can help smooth out volatility and reduce risk. Including non-U.S. stocks in your portfolio is one more way that you can enhance the diversity of your investment mix (although note that diversification does not guarantee profit nor does it ensure protection against loss).
Today, U.S. stocks represent approximately half of the total global market capitalization of all stocks. In other words, there is a big world of investment opportunities out there. Because global stocks often do not correlate closely with U.S. stocks (i.e., they move in different directions), they have the potential to be a useful counterbalance, or hedge, when U.S. stocks decline. It may sound counter-intuitive, but global investments—even those with higher risk profiles—can actually help reduce overall risk when integrated within a diversified portfolio.
Look (to the right), for example, at two hypothetical portfolios held from 1970 to 2013. The first is entirely comprised of U.S. investments (60% U.S. stocks and 40% U.S. bonds); the second one includes a relatively small allocation of global stocks (14% international stocks, 46% U.S. stocks, and 40% U.S. bonds). While the average annualized returns of both portfolios are identical at 9.8%, the global portfolio shows less volatility, or risk, as measured by the standard deviation of returns over time.
For some additional perspective, see in the chart below how different U.S. asset classes performed compared to international asset classes between 1999 and 2013. No single investment type—U.S. or international—is consistently on top or on bottom. The patchwork nature of the chart suggests how difficult it is to predict how any investment will perform in any given year—making any attempt at prediction a futile endeavor. Note also how the range of returns in some years runs the gamut from double-digit positive to double-digit negative. A diversified portfolio can help smooth this volatility and potentially produce more consistent returns over time with less risk.
The potential for growth is another argument for expanding your investment horizons beyond U.S. borders. As one of the most developed economies in the world, the U.S. enjoys a fair amount of stability. However, with stability can come slower, even stagnant growth. Just witness the explosive growth of China and Brazil over the past decade, or that of other up-and-coming markets like India, Nigeria and Vietnam, and it's clear that opportunities for investors do exist across the globe.
But a word of caution: Trying to handpick winners and avoid losers—whether region, country or company—in the global market is akin to trying to time the market. Such an approach carries more risk and more often than not doesn't work. Going back to the principle of diversification, a more prudent strategy is to spread your international investments broadly to enhance the probability of being invested in the right place at the right time and help cushion potential losses.
* * * * * * *
At the end of the day, only you can decide whether international investments are right for your portfolio—and then which ones and how much.
If you are already carrying some non-U.S. stocks or funds in your portfolio, you may find that your original allocation has shifted over time. Now may be a good time to re-balance to your target allocation. We can help you do this.
And if you're considering making your first international investments, we can help you think through that decision—and guide you in selecting and maintaining a balanced asset allocation that best fits your needs objectives.
With international investing, you may discover—as we did with our travels in South Africa—that taking the leap outside of your comfort zone can have its rewards.
Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC. Investment advisory services offered through Raymond James Financial Services Advisors, Inc. Estes Wealth Strategies is not a registered broker/dealer and is independent of Raymond James Financial Services.
Any opinions in this newsletter are those of Estes Wealth Strategies and John Estes and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice.
The information provided does not purport to be a comprehensive description of securities, markets, or other developments. This information has been obtained from sources considered reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information provided is not a complete summary or statement of all available data necessary for making an investment decision, nor does it constitute a recommendation.
Individual investor's results will vary. Past performance does not guarantee future results. Investing involves risk and you may incur a profit or loss. Diversification and asset allocation do not ensure a profit or protect against a loss.
International investing involves special risks, including currency fluctuations, different financial accounting standards, and possible political and economic volatility. Emerging-market investments are more risky than developed market investments.
Explanation of data used in charts:
- U.S. stocks are represented by the Standard & Poor's 500® Index, which is an unmanaged group of securities and considered to be representative of the U.S. stock market in general.
- U.S. bonds are represented by the 20-year U.S. government bond.
- International stocks are represented by the Morgan Stanley Capital International Europe, Australasia, and Far East (EAFE®) Index.
- International bonds are represented by the Citigroup Non-U.S. 5+ Year World Government Bond Index.
- Emerging-market stocks are represented by the Morgan Stanley Capital International Emerging Markets Index, and emerging-market bonds by the J.P. Morgan Emerging Markets Bond Index Plus.
- All values expressed in U.S. dollars. The countries/regions illustrated do not represent investment advice. An investment cannot be made directly in an index.
- Risk and return are measured by standard deviation and compound annual return, respectively. Standard deviation measures the fluctuation of returns around the arithmetic average return of the investment. The higher the standard deviation, the greater the variability (and thus risk) of the investment returns.
- The data assumes reinvestment of all income and does not account for taxes or transaction costs.