Foreign Investing: Not Mandatory, But Recommended

 |  Includes: DGS, DOO, DWX, EDIV, EEM, IDV, PID, SDY
by: Skyler Greene

One of my favorite authors on Seeking Alpha is Tim McAleenan, whose insightful articles prove that age is often immaterial to wisdom. I often quote Tim's articles because of their solid analysis and succinct explanations of important concepts.

Despite my deep respect for Tim's work, there's one issue we don't see eye-to-eye on: foreign stocks. In Tim's recent article Foreign Investing Is Not Mandatory, he laid out a well-reasoned case for why investors don't have to own foreign stocks. His core thesis was that since American blue-chip multinationals like Procter & Gamble (NYSE:PG) and Johnson and Johnson (NYSE:JNJ) operate internationally, a portfolio of multinationals automatically provides international exposure. In his own words:

If you want to make profits in every country but Cuba and North Korea, buy Coca-Cola (NYSE:KO).

While Tim's argument is certainly valid, that doesn't mean that investors can't derive additional benefit from investing in foreign stocks. Here's why.

1: Strong Long-Term Growth

One of Tim's arguments was that most "foreign investing" advice is promulgated by investment advisors seeking to capture more management profits. While this may be true to an extent, it's an argument that's somewhat irrelevant to the question of whether or not foreign investing is a good thing. After all, money managers are always going to try and capture more profits.

Simply put, emerging economies provide higher growth than developed economies. Over the last decade, the BRIC countries (Brazil, Russia, India, China) were in the spotlight. The new hot economies are the CIVETS (Colombia, Indonesia, Vietnam, Egypt, Turkey, South Africa). CIVETS countries are expected to grow GDP at 4.9% annually for the next 20 years, vs less than 2% GDP growth for G7 countries including the United States.

Investors do not have to turn to high-priced funds to gain international exposure. ETFs like the iShares Emerging Market Index (NYSEARCA:EEM) can provide some nice diversification to a portfolio for a fairly low expense ratio of only 0.67%. While EEM has underperformed the SPDR S&P 500 (NYSEARCA:SPY) for the past few years, it has more than outperformed over the last decade.


2: Higher Dividends

Foreign stocks often provide higher dividends than domestic stocks. In 2011, the SPDR S&P Emerging Markets Dividend ETF (NYSEARCA:EDIV) distributed dividends that, according to Google Finance data, represented a 4.58% payout based on the ETF price as of each dividend distribution date. In contrast, in 2011, the SPDR S&P Dividend ETF (NYSEARCA:SDY) distributed dividends representing 3.32% based on the dividend distribution dates.

As explained by Investopedia, these higher dividends are often the result of cultural differences: investors in foreign countries often demand higher dividend payouts. Coupled with the higher growth prospects for developing and emerging economies, this can result in juiced long-term returns. ETFs offering diversified exposure to international and emerging market dividend stocks include the WisdomTree Emerging Markets Small-Cap Dividend (NYSEARCA:DGS), the PowerShares International Dividend Achievers ETF (NYSEARCA:PID), the WisdomTree International Div ex-Financials (NYSEARCA:DOO), the SPDR S&P International Dividend (NYSEARCA:DWX), and the iShares Dow Jones International Select Dividend (NYSEARCA:IDV).

Before investing in such funds, investors should be aware of one important factor: foreign dividend tax withholding. This can often reduce after-tax yield. For a closer look at the ins and outs of international dividend ETFs, see this article by Morningstar.


Tim is certainly right in that domestic multinationals provide international exposure. However, this doesn't mean that you can't gain any benefits by adding some foreign dividend stocks to your portfolio. A glass of orange juice with breakfast provides vitamin C and other nutrients, but that shouldn't preclude you from eating an apple with lunch to further boost your nutrient intake. I believe any long-term portfolio should include a reasonable allocation to foreign stocks to maximize returns. (David Loeper at Forbes recommends 10-20%.)

Whether you agree or disagree with my conclusions, I value your opinions. What's your stance on foreign stock investing?

Disclosure: I am long JNJ, KO, PG, EEM.