Foreign Markets' Underperformance is an Opportunity for Rebalancing

Investors in foreign stocks have suffered through several years of underperformance. The result is a great opportunity for rebalancing today.

It’s time to rebalance your equity portfolio and put at least 35% of it in foreign stocks. The U.S. stock market has been on quite a run, and that’s has made many investors doubt the benefits of foreign investing. But the U.S. can’t outperform forever.

How should you invest overseas? Stick to mutual funds or ETFs as individual stocks are too risky. I recommend allocating the single biggest piece of one’s international stock portfolio — 40% — to Europe. I put the bulk of clients’ European investments in strong economies like the United Kingdom, Germany, Switzerland and France.

Despite the eurozone’s problems, many of the world’s best multinational companies are based in Europe. They offer both income and growth potential.

I also like other established markets: Australia, Canada and Japan, and recommend investing 10% of an international stock portfolio in Australia and Canada, and 12.5% in Japan via index funds or ETFs.

While investing in emerging markets is important too, it’s trickier because of the potential lack of transparency. Use active managers instead of index funds for developing economies. Experienced fund managers can sift through each company's financial statements and separate attractive investments from unattractive ones.

I look closely at the geographic distribution of the mutual funds we use for our clients. If a fund is heavy in a country, like Russia, that we think is unreliable or unstable, we won’t invest in it. We might accept a 2% incidental exposure to a country we’re not comfortable with, but nothing substantial. However, even in unstable countries, there are some strong companies worthy of investment.

While developing economies such as Latin America, China and India come with additional risks, they are growing fast, but I am cautious about China. The risks can be mitigated by using active management, diversifying and regularly rebalancing portfolios.

The fate of large companies is less tied to location than ever before. Even if you only hold U.S. stocks, your portfolio will still be affected by what happens outside this country. U.S. stocks make up less than 50% of the global stock market, so unless you believe that foreign companies are fundamentally less attractive investments than U.S. companies, investing a substantial portion of your portfolio abroad is the right thing to do.

Paul Jacobs, CFP, is chief investment officer of Palisades Hudson Financial Group, which manages $1.2 billion of assets. He is based in Palisades Hudson’s Atlanta office; the firm is headquartered in Scarsdale, N.Y. He can be reached at paul@palisadeshudson.com.

Palisades Hudson is a fee-only financial planning firm and investment advisor with more than $1.2 billion under management. It offers investment management, estate planning, insurance consulting, retirement planning, cross-border planning, business valuation and appraisal, family-office and business management, tax preparation, and executive financial planning and has offices in New York, Georgia, Florida and Oregon.