Money Magazine Ask the Mole

Foreign ETFs to buy now

International stocks have outperformed U.S. markets recently, but owning a diversified portfolio that covers the world is still your best bet.

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By the Mole, Money Magazine's undercover financial planner

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Have future topics for the Mole to address? E-mail him at themole@moneymail.com.
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NEW YORK (Money) -- Question: After reading thru your column Missing the Boat on International Funds, I'm totally on board with staying away from U.S. stocks. However, I have not found any info on which overseas stocks to look into. Can you give me any insight into foreign ETFs?

The Mole's Answer: With all due respect, I'm afraid you missed the point of my column. Though I did write that U.S. stock funds earned only 82% from 2003 - 2007, while international stock funds earned 168%, that is far from a recommendation to stay away from U.S. stocks. Let me first tell you why, and then I'll give some exchange traded funds and index funds that I think are a good way to get international exposure.

Why you still need U.S. stock exposure

There are several reasons you need exposure to U.S. stocks.

First, the United States comprises roughly 42% of the world market capitalization. That means the value of U.S. stocks comprises 42% of the world stock market value. The United States is still the largest single country in terms of market capitalization and to avoid U.S. stocks is to leave a big gap in a global portfolio.

Second, the fact that U.S. stocks have lagged the rest of the world is actually a reason in favor of owning U.S. stocks. I believe in buying low and selling high. Overloading with international stocks now is just performance chasing, which has been shown to result in the very thing you want to avoid: buying high and selling low.

Third, don't count on the fact that faster growth overseas translates to greater stock market appreciation, as it is already priced into the market. While the dollar has plummeted against the Euro, it's very unlikely that it will continue to do so at the same pace. In fact, it's just as likely the dollar will increase, as it has started to do in recent weeks.

I recommend a global portfolio that comprises both U.S. and international stocks. I've been recommending for quite some time that the stock portion of my U.S. client's portfolios be two-thirds U.S. and one-third international. That's because I want my clients to have a global portfolio, but having a full 58% in international exposes them to too much foreign currency risk. U.S. consumers will spend most of their wealth in U.S. dollars.

So which Foreign ETFs?

You may have been asking my thoughts on country-specific ETFs in fast growing economies like China and India. If so, my thoughts are to avoid these like the plague. While I know that China and India have fast growing economies, I don't know how their stock markets are going to perform, especially in the short-run. Nobody else does either.

Take a look at China. Over the past five years, its economy has boomed but its total market gain was almost identical to the Vanguard Total International Stock Fund (VGTSX) through August 8, 2008. That's because the Shanghai index has lost more than half of its value since October 2007.

My advice is first and foremost to recognize that you don't know which country stock markets will be hot and which ones will be cold. That's why you're better off buying the entire international stock market.

Some good ways to do this are as follows:

Vanguard FTSE All World Ex US (VEU). This ETF owns thousands of companies across all countries outside of the U.S. I think it's the best single way to get exposure to the rest of the world. It does leave out the smallest companies in the international market but it's the closest thing out there to owning the world. Annual fees are 0.25%. The mutual fund version (VFWIX) has a 0.40% expense ratio.

iShares EAFE fund (EFA). This ETF invests in Europe, Australia, and the Far East. While it certainly owns the majority of the rest of the world, it doesn't own stocks in emerging market countries or in Canada. Its annual expenses are 0.34%, so it's still a good way to own most of the rest of the world. You might need to supplement it with an emerging market ETF such as iShares MSCI Emerging Markets (EEM) and the iShares MSCI Canada (EWC).

My advice: Know that you don't know whether U.S. stocks will outperform international stocks and buy both. Then go one step further and realize the experts don't know which countries will be hot either, so own the entire rest of the world. If you own the international securities mentioned above combined with a broad U.S. portfolio like the Vanguard Total Stock Market (VTI), you own a stock portfolio that is far more diversified than most expert portfolios.

Invest globally because we have a global economy. Don't go international because it has been hot. And on the flip side, don't abandon international if it gets cold.

The Mole is a certified financial planner and certified public accountant who - in the interest of fairness - thinks you should know what goes on behind the scenes in financial planning. Want to make contact? E-mail themole@moneymail.com. To top of page

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