Stan Luxenberg
Evanson argues that foreign stocks can provide diversification for U.S. investors. A globally diversified portfolio can deliver relatively steady results, because sometimes stocks in one region may be racing while other markets trail.
This has been amply demonstrated recently. During the five years ending in April, foreign large-blend funds returned 19.25% annually, while comparable U.S. funds returned 10.52%. During the five years through December 2000, U.S. large-blend led, returning 16.19%, compared with 9.19% for foreign peers. While it pays to have a solid foreign allocation, investors should be wary of holding much more than 40% or 50% of assets abroad, says Fran Kinniry, a principal with Vanguard Group. Kinniry says that when an investor moves from having no foreign holdings to keeping 20% of assets abroad, there is a substantial diversification benefit that economists sometimes call the "free lunch." As diversification increases, the odds of suffering a bad loss fall. In other words: Investors can enjoy greater expected returns without taking on more risk. As the foreign holdings surpass 40%, the diversification benefit begins waning, and disappears entirely by the time that the foreign allocation hits 100%. "When you start moving past 50% in foreign stocks, then you may not be doing much to lower risks," says Kinniry. Still, there could be special circumstances when some investors should keep more than half of their assets abroad, says Michele Gambera, chief economist of Ibbotson Associates. Gambera cites the example of a car salesman who works for commissions. If the U.S. economy slows, the salesman's income could fall. At the same time, the S&P 500 is likely to drop.
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