If you're like most investors, you probably shy away from global investing, preferring to focus on the S&P 500 and US stocks and mutual funds. That's understandable. Most people are more comfortable in their own backyards. But by staying in your comfort zone, you're missing out a fantastic chance to reduce the total risk of your portfolio while offering additional profit potential.
To understand the benefits of going global, we need to free you from a common mistake. Investing in multinational US companies with a heavy chunk of sales in other countries does not provide you global exposure. Most people don't run the numbers, but if you did, you'd find that US multinationals don't correlate with foreign stocks. In fact, they correlate much closer with their own countries. That's because there are a myriad of other factors affecting stocks beyond where the company generates its revenue.
A couple of standard arguments for global investing remain powerful. First, global investing expands your opportunity set. The US stock market's market capitalization is approximately $15 trillion, which sounds like a lot. But the entire world's market capitalization is about $32 trillion, meaning the US doesn't quite make up half of the investment opportunities! Just by expanding your universe, you've got a better shot at finding more promising investments.
Global investing also reduces the risk in your portfolio while increasing return. No one type of equity outperforms all of the time, and diversification helps mitigate the volatility between countries, industries and individual companies. It hedges you against very bad things: war, oil shortages, natural disasters, scandals and any number of events that can derail specific companies and markets. Any blend of dissimilar categories, whether they have negative, low or no correlation, improves return over time while lowering risk.
But perhaps even more important, choosing a global benchmark helps you think about markets better. To understand the US better today, whether through global yield curves (see Data Center) or relationships between US stocks and how they perform, you need to think globally. Even for a purely domestic portfolio, you must be familiar with the global product market of the domestic companies and their international competition. If you're doing the work anyway, why not reap the benefits!
By now, it should be clear that putting fences up around your investments means you're missing out. But if not, look no further than the recent past. Foreign stocks bested their US counterparts for the fifth consecutive year in 2006!