There are two main reasons for investing in foreign stocks: opportunity and diversification. The U.S. share of world market capitalization is around 50%. Therefore, if you don’t invest in foreign stocks you’re excluding half of the world’s investment opportunities. In addition, foreign stocks can help diversify your portfolio, smoothing out long-term returns.
That is, foreign markets may move up while Wall Street retreats. Even during the 1990s, when foreign stocks trailed domestic issues, there were several years (1993, 1994, 1999) when this noncorrelation worked in favor of international investing. In 1993, for example, foreign stocks (Morgan Stanley’s EAFE Index of Europe, Australasia, and the Far East) outgained the S&P 500, 32.56% to 10.06%. In 1999, EAFE led the S&P 500 by 26.96% to 21.04%, with huge gains registered in Japan, other Asian nations, and the emerging markets of Latin America.
Research indicates that adding foreign stocks aids risk-adjusted returns: the ‘sweet spot’ in asset allocation calls for about 25% of an equity portfolio to be composed of foreign stocks. Based on historical data, this might produce the most desirable combination of excellent returns with acceptable levels of risk.