These are heady times for the global economy, and investors can be forgiven for wincing in terror as they stare at their nearest computer screen wondering why they even bother buying foreign securities.
Greece is on the verge of bankruptcy and possible exit from the euro, while China’s stock market seems to have burst. Meanwhile, the U.S. continues to add jobs at a solid clip, housing prices are jumping and consumer confidence is high. Why bother?
Despite recent developments, chances are you’re not invested enough internationally. In fact most American investors have a home bias, as Charles Schwab’s chief investment officer for equities Omar Aguilar recently told me. Now is no time for protectionism in your portfolio.
You’ve probably heard that investors have a nasty habit of buying high and selling low, as those who bailed out of stocks and into cash in 2009 can attest. This phenomenon tends to occur when well-meaning investors pay too close attention to noisy financial news and act on fear.
To be fair, folks are worried for a reason. Actually, multiple reasons:
Europe’s economic union is flux: On Sunday, the Greeks took to the polls and voted against a proposal offered by the nation’s creditors after Prime Minister Alexis Tsipras called for the referendum as negotiations with European leaders of broke down. After a less-than-productive meeting yesterday, European Commission President Jean-Claude Juncker said Europe has a plan to kick Greece out of the euro. Whether Greece and the rest of Europe can find a path to monetary coexistence remains a fifty-fifty proposition, which is slightly vexing given that no one understands the full impact of what a Greek exit will entail.
A bubble is bursting in China: The Shanghai Composite Index recently fell to a three-month low, despite strong governmental efforts to stem the decline. Close to a thousand companies have suspended trading, while the government has cut interest rates and announced plans to investigate short-sellers.
This pullback, though, comes after a dramatic increase in Chinese equities. Valuations are still frothy and the Shanghai Composite Index is up year-over-year. Chinese investors are experiencing market turbulence as national economic growth downshifts to around 7% growth, well below it’s pace ten years ago. Whether equities have more room to drop, or have found a bottom, remains to be seen.
Why no skip the dram? Because if you’re not investing overseas you’re missing out on a key element of your portfolio: diversification.
A little more than half of the stocks in the world are located outside of the U.S., yet U.S. mutual fund investors held only slightly more than a quarter of their portfolio in international stocks, according to a 2014 Vanguard study.
“The rationale for diversification is clear—U.S. stocks are exposed to U.S. economic and market forces, while stocks domiciled outside of the United States offer exposure to a wider array of economic and market forces,” says the study. Because one market can rise as another falls, investors holding between 20% to 40% of their equities in international funds experienced lower overall volatility.
Right now, it may appear obvious that the U.S. is the place to be. But other times, foreign markets outperform our own. In fact, that’s been the case for much of this year so far.
As Money’s Susie Poppick points out here, Greece is a tiny fraction of the world’s economy. And while China’s stock market free-fall may pose a larger threat to world finance, most stocks are owned by Chinese investors and most Chinese citizens don’t own stocks.
To get broad expsure to global market, look to a couple of Money 50 recommend funds. Fidelity Spartan International offers investors access to blue-chip European fare like Nestle. Or if you want a one-decision fund, look to Vanguard Target Retirement 2035 , which mixes U.S. stocks, foreign stocks, and bonds. About a third of its stock portfolio is in foreign companies.