International Index Funds
So far we have only been considering the U.S. stock market; but capitalism exists everywhere, and there are many index funds to help you include foreign stocks in your portfolio.
To keep things simple we'll just summarize two major foreign index categories,
EAFE and Emerging Markets:
||The developed economies of
Europe, Australasia & Far East
|Developing economies worldwide
Food Beverage & Tobacco
Economies similar to U.S., probably with slower growth
Economies different from U.S., potentially with faster growth
* Subject to change!
(Note that Canada gets forgotten, as usual: it's too American to be E.A.F.E., too developed to be Emerging.
You can check on global fundamentals with this S&P link.)
Advantages and Problems
Adding foreign stocks to your portfolio provides potential advantages and potential problems:
- You always get more diversification since you're owning more companies
- You get even more diversification if you invest in countries with economies based on different industries than the U.S.
- Foreign stocks often sell at lower average P/E ratios than U.S. stocks; so buying "foreign" can be an automatic way to buy "value".
- Currency fluctuations are a total wildcard: you probably won't be able to predict what effect they'll have on your wealth. (Foreign investments can be a hedge in case the dollar falls; but a falling dollar also means that Americans won't be able to afford as many foreign products, which hurts foreign companies and thus punishes foreign stocks.)
- Political problems in emerging markets are another wildcard; you have to hope everybody gets the "peace and progress" memo.
Like many capitalization-weighted indexes, EAFE and Emerging Markets have a Pareto problem,
with a disproportionate amount of their capitalization occurring in their top few countries.
You can correct for this if you wish by diversifying beyond an EAFE/Emerging Markets core,
and using indexes that track the European Monetary Union, the Pacific excluding Japan, and Latin America.
You can even add funds for individual countries that defy classification (like Canada, eh?)
Even Better: "Global Excluding US" Index Funds
Actually, that last paragraph is way too complicated.
If you build the foreign part of your portfolio with mainly a Global Ex-US fund (like the one in the box at right) and then add a smaller amount of Emerging Markets to lessen the effects of the biggest countries in the global fund, you should be doing fine.
|| Global Ex-US