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When does it make sense to invest in an underperforming asset?
This year, international stocks are struggling even more than the U.S. stock market. The Vanguard Total International Stock Index Fund, which holds nearly 8,000 stocks from around the world, is down about 25% for the year. The S&P 500 index is only down 20%.
Between a looming recession in Europe, the ongoing war in Ukraine, major losses in China's stock market and the lingering effects of the pandemic on the world's supply chain, it's no wonder international assets are struggling right now.
But it’s not just this year. U.S. stocks have outperformed their international counterparts in eight of the last nine years, according to data from BlackRock.
Despite that lackluster performance, you should probably be investing overseas anyway. The reason? Diversification, which refers to the investment strategy of owning a mix of different types of assets — stocks, bonds and more — to avoid the risk of being overly exposed to any single one. The strategy also entails buying investments in businesses of different sizes (think large and small companies), industries (like consumer staples and technology) and countries. That way when one of those assets performs poorly, other areas of your portfolio will ideally hold steady or even perform well.
Callie Cox, U.S. investment analyst at the brokerage firm eToro, tells Money that a diversified portfolio should be tailored to an individual's goals.
"People invest in different asset classes to create a portfolio...that serves what they're trying to do in their investing journey," Cox says. And international stocks, she adds, are one of the pieces.
Diversification is key
International stocks tend to do better than U.S. stocks when the S&P 500 is performing poorly, and they tend to do worse when the S&P 500 is doing well, chartered financial analyst Eric Nelson of Servo Wealth noted in a blog post last year.
“That is what you would hope for,” Nelson wrote. “It's the very essence of diversification.”
Despite their recent lag, between 1971 and 2021, the international stock market outperformed the U.S. stock market 100% of the time when U.S returns were less than 4%, according to BlackRock. When U.S. returns were less than 6%, international stocks outperformed U.S. stocks 94% of the time.
In other words, when your domestic portfolio is down, international stocks might be rising. The reverse holds true as well, and that’s what diversification is all about.
There’s also the fact that underperforming international stocks may turn out to be a good buying opportunity for investors: Experts agree that U.S. stocks won’t outperform their global counterparts forever.
Paul Quinsee, global head of equities at J.P. Morgan Asset Management, noted earlier this month that while “investors can be forgiven for wondering if the 14-year run of U.S. outperformance will continue indefinitely,” he says he still thinks international stocks are worth holding.
The risks of international stocks
Of course, international stocks come with risks, too. They’re more exposed to currency fluctuations (like the ones that are happening right now, as a strong U.S. dollar pushes other global currencies lower) and geopolitical unrest like the ongoing war in Ukraine.
International assets are also taxed differently, depending on which country they’re from, and might be subject to additional regulations.
Not to mention the fact that the international and U.S. stock markets are beginning to track each other more closely, lowering international stocks' benefits as diversifiers, Morningstar portfolio strategist Amy Arnott pointed out in a recent blog post. While Arnott says the perks of owning international stocks “aren’t as compelling as they once were," the overall benefits of diversification remain.
How to invest in international stocks
Investment giant Vanguard suggests allocating at least 20% of your entire portfolio to international stocks and bonds, while Cox adds that this allocation should also depend on your age, risk tolerance and other investments. And not to worry — you don’t have to figure out how to buy stocks in euros or yuan.
You can easily invest in international assets through a mutual fund or exchange-traded fund (ETF). There are a wide variety of international funds out there, from funds focused on a certain country to funds focused on emerging markets like China and Brazil, to funds focused on a specific region of the world, like Asia Pacific, Europe or Latin America. You can explore Morningstar's list of this year's best international stock funds here.
You might even be invested already, if you have a 401(k). Many target-date funds, which are popular investments in 401(k)s, have international exposure already baked in.
You can also buy them directly, either through international stock exchanges or via American Depository Receipts that trade on U.S. exchanges. But be careful — buying individual foreign stocks won’t give you broad exposure to foreign markets the way owning a mutual fund or ETF will.
And even if you don't think you own any international stocks, or don't want to, there's a good chance you have more global exposure than you think.
"If you're a US investor invested in some of the biggest mutual funds and ETFs out there, you're inherently a global investor as well," Cox says. That's because the largest companies in those funds (think Apple, or Procter & Gamble) "get a significant portion of the revenues from overseas," she adds.