The name of the game in retirement planning and investing is diversification. Ignoring half of the world’s market capitalization is the equivalent of tying one hand behind your back. Foreign stocks have an important place in any well-balanced equity portfolio, in our view.
If you're like most investors, you probably shy away from global investing, preferring to focus on the S&P 500 and US stocks and mutual funds. That's understandable. Most people are more comfortable in their own backyards. But by staying in your comfort zone, you're missing out a fantastic chance to reduce the total risk of your portfolio while offering additional profit potential.
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To understand the benefits of going global, we need to free you from a common mistake. Investing in multinational US companies with a heavy chunk of sales in other countries does not provide you global exposure. Most people don't run the numbers, but if you did, you'd find that US multinationals don't correlate with foreign stocks. In fact, they correlate much closer with their own countries. That's because there are a myriad of other factors affecting stocks beyond where the company generates its revenue.
Global investing also reduces the risk in your portfolio while increasing return. No one type of equity outperforms all of the time, and diversification helps mitigate the volatility between countries, industries and individual companies. It hedges you against very bad things: war, oil shortages, natural disasters, scandals and any number of events that can derail specific companies and markets. Any blend of dissimilar categories, whether they have negative, low or no correlation, improves return over time while lowering risk.
By investing in stocks you’re trading year-to-year volatility (typically) for higher long-term returns. If you can smooth these returns by diversifying globally—keeping the same equity-like long-term returns—you increase the chances you’ll be able to stick to your strategy, and achieve your investing goals.
Source: FactSet, as of 12/13/2013
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