As the U.S. equities market begins to slow down, investors are looking overseas for potential opportunities. But how much foreign exposure do you need for a diversified portfolio?
ETF investors will have to find a balance between two schools of thought: a highly globalized portfolio with international allocations that mirror their respective market values, or underweight foreign exposure due to the extra costs and volatility associated with the assets, writes Morningstar‘s director of personal finance Christine Benz.
When constructing a more long-term asset allocation strategy, investors will have decide how much foreign equity exposure they want.
For instance, among the so-called less is more investors, such as Jack Bogle, U.S. investors can get indirect foreign market exposure through large multi-national companies, which may also help investors avoid the extra costs and potential currency risks associated with foreign stock investments.
On the other hand, so-called global market-cap agnostics that weight international exposure based on their market value could hold up to half of their investment portfolio in international assets. For instance, the FTSE Global All Cap Index includes about a fifty-fifty U.S./foreign split [Embracing International Small-Cap ETFs]
The U.S. makes up about half of the world economy, so investors would only need about a 50% position in U.S. stocks. For instance, the Vanguard Total World Stock ETF (NYSEArca: VT), which follows the FTSE Global All Cap Index, includes 54.1% North America exposure, along with 22.1% Europe, 14.2% to the Asia Pacific, 9.4% emerging markets and 0.2% to the Middle East.
Still, most asset-allocation experts advise a middle ground. Benz points to target-date mutual funds as an example, with many investment shops allocating about two thirds of their allocations to U.S. equities and the rest in foreign positions, ranging anywhere from 20% foreign equity to 40%.
“The rationale behind those varying exposures gets back to volatility,” Benz said. “As investors get closer to needing their money in retirement, they shouldn’t just segue to a more conservative stock/bond mix; their intra-asset-class exposures should also change to emphasize more conservative investment types. Because foreign stocks typically entail some currency risk as gains or losses are translated from foreign currencies to dollars, Morningstar research has concluded that foreign weightings should decline accordingly.”
For more information on investing with ETFs, visit our ETF 101 category.
Max Chen contributed to this article.