Why should you invest in Foreign Stocks?

The answer to the title question is: For better returns and diversification purposes.

Simply put, in this age of globalisation it is almost a requirement to invest in foreign countries if ones to make above average returns. It does not mean putting 5 to 10% as most Americans do. it means allocating 30-40% of ones portfolio to foreign equities. An average investor in the US has less than 10% of his portfolio invested in foreign stocks.

Of course there are many risks to investing in foreign stocks.For a brief summary go to the SEC page on International Investing.

Today foreign companies are competing and growing rapidly when compared with US companies. For example, the market capitalization of all the stocks listed in the New York Stock Exchange (NYSE) is about $27.1 Trillion as of December 31,2007. Out of this, 421 foreign companies’ capitalization is $11.4 Trillion. This shows that foreign companies are increasingly becoming more powerful and important in the global market place. On a worldwide basis the US markets constitutes only 45% of the total market capitalization of all companies. In addition to the NYSE there are many more foreign stocks listed in the Amex,Nasdaq and the OTC markets.

In addition to the above reasons, investing in foreign stocks may provide higher returns than investing in US stocks.

The following table and chart compares the Total Return of MCSI EAFE against US Indices for a period of 25 years. The MCSI EAFE Index is the all Non-US major stock markets of the world including Australasia, Europe and the Far East.

Total Return – MCSI EAFE Vs. US Index

Year All Major Stock Markets outside US US
1983 25% 22%
1984 8% 6%
1985 57% 33%
1986 70% 18%
1987 25% 4%
1988 29% 16%
1989 11% 31%
1990 -23% -2%
1991 12% 31%
1992 -12% 7%
1993 33% 10%
1994 8% 2%
1995 12% 38%
1996 6% 24%
1997 2% 34%
1998 20% 31%
1999 27% 22%
2000 -14% -13%
2001 -21% -12%
2002 -16% -23%
2003 39% 29%
2004 21% 11%
2005 14% 6%
2006 27% 15%
2007 12% 6%

Chart: Total Return – MCSI EAFE Vs. US Index

US-NonUS-Returns

As we see in the above table and chart, in the past 25 calendar years foreign stocks have outperformed US stocks in 15 years.

From the above data, we can also infer the following:

1. In the past 5 years (2003 to 2007), foreign stocks have returned far higher returns than US stocks for each year. The year by year return difference is as follows:

Years 2003 and 2004 – Foreign stocks returned 10% higher than US stocks
Year 2005 – Foreign equities’ return was 8% higher than US stocks
Year 2006 – International stocks returned 12% higher then US stocks
Year 2007 – Foreign stocks returned 6% higher then US stocks

While some portion of this higher returns is due to the dollar depreciation, the majority is due to foreign companies making higher profits than our domestic ones.

2. From 1995 to 1999 during the high tech craze, the US markets outpaced international markets.

So overall foreign stocks performed better in most of the past 25 years. As US economy struggles to recover it may be the right time for US investors to take a fresh look at foreign markets and invest according to their risk appetite.

Question:

What is you portfolio allocation for foreign stocks?. Do you think you need to re-allocate your portfolio now?. Which country/region is your favorite? Post your story on portfolio allocation in the comments section.

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