Wise Up. Send Your Money Abroad
Yes, overseas markets are up big, but chances are you still haven't bought enough of the world.
(MONEY Magazine) - Where can you earn the biggest returns right now? Anywhere but here, apparently. For the fourth year in a row, international stock funds outperformed domestic ones in 2005, with an average gain of 17.5% vs. 6.9%. That triggered the predictable stampede of performance-chasing investors. Some $155 billion cascaded into foreign and global stock funds last year, 40% more than in 2004 (itself a record year). That's 75% more cash than went into U.S. equity funds.
Ordinarily, when I see those kinds of hot money inflows, I recommend investing just about anywhere else. Fact is, though, most of us don't have enough money in foreign stocks, so we may be doing the right thing for the wrong reasons. "It's always a mistake to chase after a hot market," says Gregg Wolper, a senior analyst with Morningstar. "But it's important to own international funds."
If you've been jumping in and out of foreign funds--or avoiding them altogether--it's time you understood the real reason to invest abroad: Done sensibly, it makes your portfolio safer and boosts your long-term returns. Here's why.
The Zig and Zag of It
Foreign markets don't move in lockstep with U.S. exchanges. True, developed markets move in the same general direction as U.S. stocks, since big companies here and abroad play on a global scale. But returns vary widely, as the past few years have shown. And emerging markets in Latin America and Asia often move in the opposite direction from the U.S.
In addition, international funds let you invest in a currency other than the dollar. When the greenback is weak, as it was in 2004, you get a boost when your foreign fund's returns are converted into dollars. Of course, when the buck strengthens, as it has lately, you lose a little in translation.
Toyota vs. GM
Foreign stocks also improve your chances of earning strong returns. "Many of the most innovative companies are internationally based," says Morningstar's Wolper. "That includes most of the leading cellular-phone makers and the best-performing auto companies." Moreover, markets such as Brazil and China are growing faster than the U.S.
Given all that, financial advisers typically recommend that you keep 25% to 35% of your equity portfolio in foreign stocks. Here are three tips for getting the most out of your world travels.
• TAKE YOUR SEASICKNESS PILLS Japanese stocks slid 7% during three days in January, when an investigation into an Internet company spooked investors. Developing markets are especially risky--it's not uncommon for them to lose 20% in a quarter. If you're cautious, you may do best with an allocation of less than 20% to foreign stocks, while bolder investors may be able to handle 35% or more.
• BUY BIG The bulk of your foreign stake should be stashed in large-company funds, which will bounce around less than small-cap or midcap funds. Two top choices: Vanguard International Growth (VWIGX) or Oakmark International (OAKIX), both MONEY 65 funds. As in the U.S., blue chips have lagged smaller stocks lately around the world. But that's all the more reason to make sure you own them now. "The most undervalued stocks today are large-caps," says David Herro, manager of Oakmark International. If you have more taste for risk, put another 5% into a small-cap or emerging markets fund such as the MONEY 65's T. Rowe Price International Discovery (PRIDX) or SSgA Emerging Markets (SSEMX).
• DON'T GO NATIVE If you've owned emerging markets or foreign small-cap funds lately, your investment has grown way beyond your initial allocation. Avoid the temptation to keep piling in. Move some of your overseas stash into laggards like your big-cap U.S. funds. You'll end up selling high and buying low--a winning strategy anywhere in the world.
Staying Too Close to Home
While money has been flowing into foreign-stock funds, the typical 401(k) investor doesn't have enough invested abroad.
MONEY GOING INTO FOREIGN FUNDS (BILLIONS)
TYPICAL 401(k) ASSET MIX
International, emerging mkts. 6%
Stable value 22%
Bonds, cash 5%
Company stock 23%
Domestic equities 29%
NOTE: Net new flows into international and global equity/balanced funds.