Four Reasons to Invest Internationally

Chances are, right now you are surrounded by things that were invented, assembled, or grown outside the United States. We've become very accustomed to buying goods from other countries. There's no reason why we shouldn't also purchase investments from outside the U.S., as well. In fact, there are plenty of arguments for how you'll be wealthier for doing so. Here are four of them.

1. It's a big world out there.

While the U.S. stock market is the largest in the world, it still makes up less than half of the $24.2 trillion value of all the stocks in the world, as of the end of 2010. Here's how the global stock market breaks down:

Source: Ibbotson Stocks, Bonds, Bills, and Inflation Yearbook

Investors who restrict their portfolios to U.S. stocks are literally missing out on a world of opportunity.

2. The U.S. is not always number one.

The following table shows the average annualized returns of stocks from various parts of the world from 1970 to 2010, broken up by decade and the entire period:

*MSCI Europe, Australasia, and Far East Index. Source: Ibbotson Stocks, Bonds, Bills, and Inflation Yearbook

As you can see, the long-term returns for each region over the entire four-decade period are similar, but the returns are quite different from decade to decade. In only the 1990s was the U.S. stock market the leader, and it was the worst-performing stock market in two of the decades (the 1970s and 2000s). In other words, there's no compelling historical argument for ignoring international investments.

3. The value of diversification

When assets have similar long-term returns but dissimilar shorter-term returns, holding a mix of these investments can produce more money than the individual parts on their own. For an illustration, check out how much $1,000 turned into when invested in Pacific stocks, U.S. stocks, and European stocks, as well as a global portfolio made up of equal parts of the aforementioned three categories.

Source: Ibbotson Stocks, Bonds, Bills, and Inflation Yearbook

The whole exceeded the sum of its parts, and it didn't require investors to predict which region would come out on top. Yes, correlations among the world's stock markets have gone up over the past decade, but that doesn't mean U.S. stocks and international stocks perform identically each year. This is because the return of an international stock to U.S. investors is due to two factors: 1) the price performance of the stock, and 2) the changes in value between the currency of the stock's home country and the U.S. dollar. This makes international investing a hedge against a falling greenback. And because currencies change in value relative to each other on a daily basis, there will always be a difference in performance between U.S. stocks and international stocks - and thus a diversification benefit.

4. Not all future innovation will be in America.

In an interview on the Motley Fool Money radio show, Harvard professor Niall Ferguson pointed out that when it comes to originating patents, the top country is Japan, not the United States. South Korea takes third place, and China will unseat Germany as the number four country in a couple of years. Ferguson claims that, by some measures, the U.S. has been in decline since the 1970s. Even if you think that's overly pessimistic, there's no denying that the rest of the world is catching up in terms of economic development and innovation. One way to benefit from that “catching up” is to own international stocks.

The risks of owning international stocks

If you consider volatility as a good measure of risk, then international stocks are more risky than U.S. stocks. But you also have other risks with non-U.S. equities, such as political risk that comes from investing in countries with unstable governments or less respect for property rights. Also, corporate governance and investment exchanges in many countries are not as developed and regulated as in the U.S., leading to a higher potential for manipulation and fraud. Finally, there's the risk that an investment's home currency will fall in relation to the dollar, which would reduce an American investor's returns.

The bottom line

These days, investing overseas seems particularly scary. Every day, the news is filled with stories about Europe's debt troubles, upheaval in the Middle East, and slowing emerging markets. But amidst all the bad news, the Vanguard Total International Stock Index is up almost 12.9% so far in 2012, compared to 9.3% for the S&P 500. You've likely heard that investing when everyone else is pessimistic is a good strategy, and that seems to be the case so far this year. This is not to downplay the risks, which are very real, and the situation can change very quickly. But what won't likely change is the potential rewards that come from owning a diversified, long-term portfolio that contains a healthy dose of international stocks.

The original article can be found at Reasons to Invest Internationally

This is a post from staff writer Robert Brokamp of The Motley Fool. Robert is a Certified Financial Planner and the adviser for The Motley Fool's Rule Your Retirement service. He contributes one new article to Get Rich Slowly every two weeks.