The US is the largest economy in the world, with a GDP of about $16.8 Trillion for 2013. By comparison, Japan is under $5 Trillion, and China is under $10 Trillion, although the population of China is several times ours.
The World GDP is about $77 Trillion, meaning that the US accounts for about 22% of the world’s output, having less than 5% of the population. Why not place the bulk of our investments right here? Well, the rest of the world creates about $60 Trillion in economic activity, so by not investing internationally, you are missing out on about 78% of the world's economic activity!
The big question is, “How do I do it?” Given the uncertainties of the world economic, social and political climate, my first observation is to keep your exposure limited. As with any investment, owning international equities can be a great part of a balanced portfolio, but concentrating too much on any sector can expose you to excessive risk.
There are many ways to buy into the international sector. You can invest in individual countries by purchasing index funds that mimic the exchanges, similar to buying the DIA or SPY here. Some of the major players include Canada, Mexico, Hong Kong, Brazil, most European countries, China, etc... There are also Index Shares that mimic broad indices, the best known of which may be the EAFE Index, covering Europe, Asia, the Far East, and Australia. These shares are inexpensive to buy, own and sell, and they are well-diversified. There are also actively-managed mutual funds that deal only in international equities. Owning actively managed funds vs. exchange traded funds is a matter of personal preference. Both have pros and cons, with the key difference being cost to own. Actively managed funds have higher costs, but you are paying for a team of professionals to invest for you. Exchange traded funds are cheaper, but no one is actively watching your money for you.
Lets look at some results. I compared the EAFE Index to Oakmark International for YTD, 2 year and 5 year performance, and found that the results were mixed, and by a lot. In the absence of a pattern, I turned to the international news scene. Lately, Europe seems to be in a very spotty recovery, with some countries doing quite well (Germany), and other on the brink of default (Greece). China is growing, but a slower rate than they have been. Their stock markets are tanking. Japan is mired in the ‘80s, and North America is doing OK, but uncertainty abounds here, as well. Given all that, I believe that for the time being, active management in an International Fund has an edge over the passive index.
Owning foreign bonds is another way to gain international exposure, but I am not an expert on the topic, as there are too many variables. Domestically, a good way to spread exposure to equities and debt is through balanced mutual funds (also called asset allocation funds). Similarly, this can be dome in the International arena. International Balanced Mutual Funds are readily available in the marketplace, and to me, they offer the best possible diversification in a volatile world. Right now, we are shying away from indexing and individual countries for the most part because of their volatile nature. I still believe that international exposure is an important diversification tool, and an important part of any balanced portfolio.