Diversification, one of the bedrock principles of investing, didn't work in 2008.
There was simply no place to hide in the global slowdown, and international stocks struggled more than U.S. shares: The S&P 500 fell 38.5% last year, and benchmark international indices did even worse.
The MSCI EAFE (Morgan Stanley Capital International/Barra Europe, Australasia and Far East Index), a basket of large-company shares in developed markets outside the U.S. and Canada, dropped 45.1%. The MSCI Emerging Markets Index, meanwhile, slid 54.5%.
Still, it's wise to include a broad mix of stocks in your portfolio: growth and value, large-cap and small-cap, a variety of sectors and, yes, international shares. Diversification provides the best opportunity for long-term growth, while minimizing risk. And many advisers believe investing internationally can maximize those benefits.
Historically, that's been the case. Consider these numbers through the end of 2007. Foreign stocks, and those in emerging markets, offered the best long-term returns.
Why invest internationally? Since more than half the world's stocks are outside the U.S., spreading your money can reduce risk and allow you to invest in global growth. It can also protect your portfolio when the dollar weakens. Diversification usually works because foreign markets tend to move differently than ours, and may offer gains when U.S. stocks retreat.
While foreign markets can add risk, they also offer greater potential. In late 2008, T. Rowe Price (TROW) (Stock Quote: TROW) portfolio manager Ray Mills pointed out that European and emerging-market stocks were trading at 9.2 and 8.7 times earnings, compared with 12.5 for Japan and 11.6 for the U.S.
(TROW) "Valuations are exceptionally cheap, with many companies selling for less than book value or at extremely low historical P/E ratios," Mills said in a press briefing. "Emerging markets are on sale."
The prime reason? Funds' diversification can cut risk, and allow you to rely on indices or experts to pick stocks in unfamiliar markets.
Regional and country funds focus on stocks from a geographic area or nation. Each category offers funds with any variety of focus: small-cap or large, value or growth, tech or industrials -- the list goes on and on.
- Consider how much international exposure you want. Many advisers recommend a foreign allocation of 10% to 20%, while others advocate as much as 40%.
- Be aware of how much international exposure you already have. Domestic funds may include foreign stocks.
- Consider exposure to both developed regions and emerging markets.
- Think about limiting exposure to multinationals and large-company world funds, which may correlate strongly with domestic markets.
The bottom line? Despite the wounds of 2008, most advisers believe diversifying is key to successful investing. When building a foreign stake, spreading holdings among markets, styles and market capitalizations can maximize your portfolio's potential and reduce risk over the long term.