Better international investing, like all investing, starts with a plan and not just a tip from a friend. Investors are always on the lookout for the ‘Holy Grail’ in investing. I’m often asked ‘what’s hot?’ There’s a tendency in human behavior and certainly in behavioral finance to go where the crowd goes based on the idea that collectively there’s safety in numbers and “they” must know something that you don’t want to miss.
Well, remember what The Great One (Wayne Gretzky) said when asked what made him such a good hockey player: He skated to where the puck was going to be not where it had been.
The same can be said for investing. Investors should have more allocated to the international space considering that more than half of global business earnings are made overseas. But like anything else in investing, you need to expose yourself to lots of asset classes and in this case countries to help lower your overall risk of loss. It seems counter-intuitive but spreading your investments around will actually lower the potential risk of loss.
(Now if you’re a ‘trader’ that’s another thing. Go Big or Go Home might be the typical motto for a rapid-fire trader looking to take advantage of a pricing discrepancy or a short-term trend to maximize capital gains. But most individuals lack the tools, time and temperament to be traders so this is focused on the most likely strategy that works for the rest of us: diversification through asset allocation).
International funds have received a lot of attention in recent years, and this should come as no surprise. For starters, it has become increasingly common for investors to build multi-fund international portfolios rather than rely on individual foreign offerings for all their overseas exposure. Further, international funds have posted exceptional gains in recent years (except in 2008 and 2011). This may sound good if a significant part of your portfolio is devoted to international funds, but be sure the popularity and performance of overseas offerings hasn’t made you complacent.
In fact, it’s just as important to periodically reexamine the parts of your portfolio that have done well and reevaluate the portions that have lagged. It may be hard to rebalance – maybe because of lack of time or because of emotion. But while we’re not inclined to sell our winners, it’s the right thing to do in order to get back into balance and reduce risk. Likewise, there’s a tendency to either hold on to lower-performing assets or dump them altogether when the better thing to do is add to a position to take advantage of the “sale price” of these assets.
If you do take on international funds, remember to keep both your near-term expectations and your overseas exposure in check. You can also consider conservative foreign funds.
The first step is to set reasonable expectations for the short- to mid-term prospects of international funds. The superior relative gains posted by various types of overseas offerings in recent years may not be sustainable in the long run, as illustrated by weak international performance in 2008 and 2011.
When superior performance of overseas offerings does happen, check to see whether their overall foreign exposure exceeds the upper end of their international allocation range. A great portfolio performer can take on a larger percentage than you intended. Keeping an eye on your international allocation can help lower the overall risk of a portfolio.
The illustration here paints a rather clear picture of this. In 1970, this portfolio began with an equal allocation to international stocks, U.S. stocks, and U.S. bonds. However, due to the strong performance of international stocks during the 1980s and 1990s, allocation to this asset class jumped to 52%.
While many might overlook this shift in international exposure, keep in mind that international stocks have historically been riskier than their U.S. counterparts. As a result, the portfolio may take on an additional level of risk.
If you need to rebalance your overseas portfolio to reduce overall risk, or seek more foreign exposure, consider conservative foreign investment vehicles or at least assets that historically do not necessarily move in tandem with other assets or countries. Generally, this is why I prefer dividend-paying stocks or Exchange Traded Funds of non-financial firms overseas. Aggressive international investments have a higher probability of incurring damage during a prolonged downturn. Investing in conservative foreign funds can help balance this risk.
