I frequently write about what investors should and should not include in their retirement accounts, and no discussion of retirement would be complete without mention of foreign stocks and how to properly incorporate them into your portfolio. Should things go poorly here, particularly in terms of exchange rates or high inflation, foreign stocks provide great protection. In addition, it is good to diversify retirement savings as much as possible, and investing in a non-U.S. economy is an important element of diversification. Before investing in foreign stocks, investors need to know the benefits, and more importantly, the risks of doing so.
The most obvious benefit to investing in foreign companies is growth potential. Think of the United States as Johnson and Johnson (NYSE:JNJ), a well-established, stable blue-chip. While stable, there is not much potential for rapid growth. A country such as India is comparable to a large, but newer company which still has untapped sources of growth. China, for example, has grown at an average rate of 10% annually for the past 30 years, with much more room to grow. Economic output in the United States is $48,000 per person. Compare that with $8,000 in China and $4,000 in India, and it's easy to see that there is still a significant gap to close.
However, investors should be aware of the risks associated with investing in emerging markets. Developing countries have a disproportionate reliance on exports. In other words, if we stop buying for whatever reason, they are in serious trouble. Legal standards and business transparency are also luxuries that we enjoy (for the most part) but can be very loose or even non-existent abroad. Also, exchange rates can turn an otherwise solid investment bad, simply because the currency the company makes its money in becomes less valuable relative to ours.
None of these risks are too large; investors just need to be aware. I recommend that between 15-20% of an investor's stock holdings be in international companies, or companies with high exposure to international markets. This money can be allocated to investments of varying risk levels.
The least risky way to get foreign exposure is to buy U.S. companies that do a large chunk of their business abroad. My favorite U.S. based multinationals for the long term include AT&T (NYSE:T), Amazon (NASDAQ:AMZN), Coca Cola (NYSE:KO), ExxonMobil (NYSE:XOM), International Business Machines (NYSE:IBM), and Visa (NYSE:V). The list goes on, these just happen to be my particular favorites.
Another great way to play foreign stocks, without trying to pick individual companies on international exchanges, is to buy foreign index ETF's that track the country you are interested in. My favorite foreign ETF's include
- iShares FTSE China 25 Index Fund (NYSEARCA:FXI) - 2.47% dividend and 10.64% average return since inception in 2004. Invests in the largest companies in the Chinese market.
- Market Vectors China ETF (NYSEARCA:PEK) - Invests in a much broader basket of stocks, the CSI 300 index, with a 0.72% expense ratio.
- iShares MCSI Hong Kong Index Fund (NYSEARCA:EWH) - Traded since 1996, this fund follows the Hong Kong index. With a low 0.52% expense ratio, this fund pays an annual dividend of 2.94% and has averaged a 12.85% return over the last 5 years.
- PowerShares India Portfolio (NYSEARCA:PIN) - tracks the Indus India Index (say that 3 times fast). Expense ratio is 0.79%.
- iShares MCSI Brazil Index Fund (NYSEARCA:EWZ) - Since inception in 2000, has averaged an 11.52% annual return tracking the MCSI Brazil index. Pays a 2.7% dividend and has a reasonable 0.59% expense ratio.
- iShares MCSI Australia Index Fund (NYSEARCA:EWA) - Australia is one of my favorite countries due to its strong economy and growth. This fund has averaged a very impressive 15.45% return over the past decade, while paying a 4.7% dividend. Expense ratio is 0.52%.
- iShares MCSI Canada Index Fund (NYSEARCA:EWC) - Canada is my favorite "sleeper" country, due to the fact that a lot of Americans don't consider it much of a foreign country. Canada has been one of the best growth stories in the world over the last decade, averaging a 14.28% return and paying a 2% yield.
Other favorites, but not particularly suited for a retirement portfolio are Mexico (NYSEARCA:EWW), South Africa (NYSEARCA:EZA), and the SPDR S&P Emerging Middle East and Africa ETF (NYSEARCA:GAF). These may be worth a look, depending on your particular risk tolerance.
In closing, all investors should have a significant exposure to foreign markets in their retirement portfolios for both growth and protection. The particular countries invested in should depend on the investor's risk tolerance and personal preferences. It is my personal belief that everyone should have some exposure to China, and beyond that, there are plenty of countries to choose from with tremendous growth prospects and strong economies, so an investor should go with the countries that he or she is most comfortable with.