Investing in International Stock Funds

Most advisors suggest investing between 15% and 25% internationally

Map of world made of various currency
••• Getty Images/Thomas Northcut

Buying foreign stocks, stock exchange-traded funds (ETFs), or international mutual funds can be a great way to diversify your portfolio. But first, you'll need to decide how much you want to allocate to foreign investments.

In part, the answer will depend on your appetite for risk and the length of your investment horizon. While there's no right answer for everyone, there are a few important guidelines that can help guide your decision.

Slicing up the Pie

One way to begin is to look at the size of the U.S. stock market in relation to the rest of the world. Picture a pie chart of all the stock markets in the world, with each slice representing a particular country's stock market. The bigger each market, the bigger its slice of the pie.

The U.S. accounts for roughly $33 trillion of the world's $68 trillion total stock market value, or about 49%. So if you wanted to divvy up your portfolio in the same manner as our imaginary pie, you would simply invest 49% of your money in U.S. stocks, and the rest in foreign markets.

But in practice, a 51% allocation to international stocks is probably too aggressive for most investors, especially those who are new to international investing. This is because international markets often exhibit greater volatility than the U.S., making them riskier.

On the other hand, if you only invest a small amount overseas, you won't be able to take full advantage of the many benefits that international markets have to offer, including the ability to diversify against any domestic downturn.

The 20% Solution

As with a lot of things, the solution lies in moderation. Most financial advisers recommend putting 15% to 25% of your money in foreign stocks, making 20% a good place to start. It's meaningful enough to make a difference to your portfolio, but not too much to hurt you if foreign markets temporarily fall out of favor. Besides, you can always ratchet up your exposure as you become more comfortable with international markets.

While the precise allocation to foreign stocks will differ from one investor to another, the worst thing anyone can do is flip flop between having too much exposure and not enough. So once you've settled on a number that suits your comfort level, stick with it. Don't make the mistake of trying to outsmart the markets by jumping in and out of foreign stocks.

Finally, it's important to make sure your international investments are spread across various regions and countries. Putting 25% of your money in say, China, and the rest in the Dow Jones isn't what international diversification is all about. Make sure you have evenly balanced exposure across Europe, Asia, and emerging markets.

Ways to Diversify

There are many different ways to spread out your international investments across multiple countries. Often times, ETFs and global mutual funds are the easiest ways since they don't involve buying individual stocks or using foreign brokerage accounts.

The Vanguard FTSE All-World Ex-U.S. ETF (NYSE: VEU) is one of the most popular and least costly options with holdings around the world. When selecting funds like these, investors should ensure they're not buying more exposure in U.S. markets, since they already have exposure in the rest of their portfolio. Stick to "ex-U.S." funds to do so.

Investors should keep an eye on expense ratios when selecting these funds since these expenses are the easiest to control in terms of generating returns. Seemingly small expenses can quickly add up to tens of thousands of dollars or more over a lifetime of investing.