The key to success on the golf course is the variety of clubs in your bag. Even the most talented golfer would be hard pressed to post a good score if her bag held just a handful.
The same is true with investing. If you limit the universe of investments in your portfolio, you are by definition limiting your opportunities. And many U.S. investors are too focused on U.S. stocks. Globalization is no longer just a trend, but a reality that should be reflected in your portfolio.
The rise and fall of economies
As seen with the economic expansion of the BRIC nations (Brazil, Russia, India and China) in the 2000s, no single nation has a monopoly on growth. Over time, economic growth shifts from region to region—and back around the globe again.
About 200 years ago, however, the BRIC nations, then led by China and India, dominated the world economy, as they made up about 50% of world economic output. At the dawn of the 19th century, the United States was a small emerging market. But over the 1800s and 1900s, the U.S. economy grew.
At present, the U.S. share of world GDP is about 22%—an impressive amount, but why would you ignore the 78% of world GDP that exists outside the United States?
Diversification played out on courses and bourses
Markets have become increasingly globally diversified—a trend that is mirrored nearly everywhere, even at the Masters Golf Tournament.
During the 2015 Masters Tournament, the geographic distribution of the golfers’ home countries almost exactly matched the composition of the stocks in the MSCI All Country World Index.
This is not just a random comparison. Not only has the overall field for the Masters expanded globally over the years, but Masters winners have also come from a wider global pool.
For the first 45 years of the tournament, which began in 1934, Masters champions came from only two countries—the United States and South Africa. Since then, winners have come from all over: 51% from the United States, 3% from Canada, 14% from the United Kingdom, 17% from Europe (excluding the U.K.), 3% from Asia Pacific and 12% from emerging-market countries.
You may not play (or follow) golf, but your portfolio should likewise benefit from a global focus, because the leaderboard of “winning” economies is always shifting. So far in 2015, many overseas economies have posted better-than-expected economic data. That is a stark reversal of last year’s trend in economic and market performance, when the U.S. economy was surprisingly strong while growth in other regions was disappointing.
How global should you go?
As a general guideline, Schwab suggests you consider investing between 25% and 50% of your stock portfolio outside the United States. Where you fall along that range depends on how much of your overall portfolio is invested in stocks—the bigger your stock allocation, the more you’ll want to tilt toward international in order to properly diversify.
At the same time, you need to factor in your stomach for risk, as investing abroad may expose you to different types of risk, including currency fluctuations and geopolitical shifts, among others.
Bearing in mind these additional risk factors, you may want to consider dividing your international stock investments between developed-country stocks and those from emerging markets. Emerging markets, by definition, tend to have the fastest-growing economies, and that can in turn spur strong performance in stocks based in these countries, both from internal demand and through their ability to sell goods and services into other markets.
That said, these stocks also can be more volatile than investments in established companies from developed countries, which can accentuate the existing risks of investing overseas.
To balance the risks and rewards of emerging markets, Schwab suggests you limit your investments in them to one-third of your international stake. So, for example, if you decide to invest 30% of your overall stock portfolio in international stocks, you might consider putting 20% of your overall stock portfolio into developed-country stocks and 10% into emerging markets.
Globalization in action
Schwab believes low-cost index mutual funds and exchange-traded funds (ETFs) can provide the foundation for a well-diversified portfolio. But because many international markets—especially emerging markets—are not as efficient as U.S. and developed markets, you may also want to consider carving out a piece of your international portfolio to invest in an actively managed fund.
A talented (and cost-efficient) active manager may be better positioned to both manage the risks and take advantage of opportunities in markets where every piece of data is not picked over and instantly disseminated, as it is in the highly efficient U.S. market. Keep in mind, though, that international and emerging-market funds can be among the most expensive mutual fund investments, due to their higher management costs.