Why You Should Add International Stocks to Your Retirement Portfolio?

Adding international stocks to your retirement portfolio can be a powerful way to diversify your investments, enhance returns, and mitigate risks. While many retirees primarily focus on U.S.-based assets, expanding globally with international investments opens up opportunities that can enrich your retirement journey.

In this article, we'll explore why international stocks are a great addition to your retirement portfolio, the potential risks, and how to navigate the world of global investing effectively.

What You Will Learn

• Why Invest in International Stocks?
• Potential Challenges of International Investments
• Types of International Markets
• How to Invest in International Stocks
• Strategic Considerations for Adding International Stocks to Your Retirement Portfolio
• Historical Performance of U.S. vs. International Markets

The Case for Global Investing

Did you know that the average U.S. investor allocates roughly 80% of their equity portfolio to domestic stocks? This significant bias towards U.S.-based investments is common, but it may not be optimal for your long-term financial health.

By adding international stocks to your retirement portfolio, you can access broader opportunities across different economies, industries, and currencies. This diversification helps reduce the impact of local market downturns, enabling you to benefit from growth in other parts of the world. In this guide, we will take a closer look at why global investing and international investments should be part of your strategy.

Image source: RBC (https://www6.royalbank.com/en/di/hubs/investing-academy/article/home-country-bias/jy4l8s2k)  

Why Invest in International Stocks?

Here are five compelling reasons why you should add international stocks to your retirement portfolio:

1. Better Portfolio Diversification

Diversification is key to risk management. By adding international stocks to your portfolio, you gain access to diverse markets that may behave differently from the U.S. market. This means if there's a downturn in the U.S., international markets may still be performing well, providing a cushion for your overall portfolio.

For example, during certain economic cycles, European or Asian markets have performed significantly better than U.S. markets. By having exposure to international stocks, you improve your chances of achieving consistent returns regardless of what's happening domestically.

2. Access to High-Growth Emerging Markets

Emerging markets like China, India, and Brazil offer some of the highest growth opportunities in the world. These economies are expanding rapidly, often outpacing developed markets in terms of GDP growth.

In the 1990s, the Chinese stock market saw explosive growth, providing investors with incredible returns. Today, emerging markets are still positioned to offer excellent opportunities as they develop their infrastructure, technology, and consumer base.

3. Currency Diversification

Investing in international stocks also exposes you to different currencies. This can be beneficial when the U.S. dollar weakens, as foreign assets may gain value relative to the dollar. Currency diversification can therefore act as a hedge against fluctuations in your home currency.

For instance, if the dollar is depreciating, assets denominated in stronger foreign currencies can provide better returns in U.S. dollar terms. Currency diversification adds another layer of protection to your portfolio.

4. Increased Investment Opportunities

When you expand your investment horizon globally, you have access to a much broader range of industries and companies. For example, you might find attractive investment opportunities in European utility companies that offer high dividends, or Asian tech giants that dominate their regional markets.

With more options, you can create a more robust portfolio that includes sectors that may not be as prevalent in the U.S., such as luxury goods, natural resources, or international banking.

5. Managing Sequence of Return Risk

Sequence of return risk is a major concern for retirees withdrawing funds from their portfolios. Adding international stocks can help mitigate this risk by smoothing returns. Global diversification ensures that your portfolio isn’t overly reliant on one economy, providing some stability during periods of domestic market downturns.

Potential Challenges of International Investments

While international investing offers many benefits, it’s important to understand the challenges involved. Here are some of the potential problems you may face:

1. Political and Economic Risks

International investments often come with increased political and economic risks. Countries outside the U.S. may face instability due to factors like changing government policies, currency devaluation, or geopolitical events.

For example, emerging markets are prone to risks like political upheaval, domestic terrorism, or nationalization of companies. It’s important to be aware of these risks and choose markets with sound economic fundamentals.

2. Currency Volatility

While currency diversification is a benefit, it also introduces the risk of currency fluctuations. If a country’s currency depreciates significantly, it can negatively impact the value of your investments. Understanding the underlying factors that drive currency values and considering hedging strategies may help mitigate these risks.

3. Opaque Financial Disclosures

In some international markets, companies may not adhere to the same level of transparency as U.S. firms. Investors may face challenges in obtaining accurate and timely financial information about international companies. Developed markets typically have higher standards for financial disclosures, while emerging or frontier markets may lack transparency.

4. Less Liquidity

Foreign stocks, especially those in emerging or frontier markets, can be less liquid compared to U.S. stocks. This means it might be harder to buy or sell large quantities without significantly affecting the price. Illiquidity can pose risks if you need to quickly access funds.

Types of International Markets

To make informed decisions, it's crucial to understand the different types of international markets. They are typically categorized into three groups:

1. Developed Markets

Developed markets are the largest and most stable markets globally. These include countries with strong economic structures, stable governments, and transparent financial disclosures. Investing in developed markets provides relative stability and lower risk compared to emerging or frontier markets.

Examples of Developed Markets:

• United States
• Canada
• United Kingdom
• Japan
• Australia

2. Emerging Markets

Emerging markets are countries with economies that are growing quickly but are not yet fully developed. They offer higher growth potential but also come with increased risks compared to developed markets.

Examples of Emerging Markets:

• China
• India
• Brazil
• Russia
• Mexico

Emerging markets often attract investors because of their rapid industrialization and growing consumer base, but it’s essential to balance these opportunities with the potential for volatility.

3. Frontier Markets

Frontier markets are the least developed markets in the world. They are characterized by smaller economies and often lack the infrastructure of emerging markets. Investing in frontier markets can be highly speculative, as they carry the greatest risks but also the potential for significant rewards.

Examples of Frontier Markets:

• Vietnam
• Bangladesh
• Morocco
• Sri Lanka
• Croatia

How to Invest in International Stocks

There are several ways to start investing in international stocks, each with its own benefits and considerations.

1. Exchange-Traded Funds (ETFs)

ETFs are a popular way to gain exposure to international stocks. They are collections of stocks that track a specific index, allowing you to invest in an entire country or region with a single trade. ETFs are highly liquid and cost-effective, making them an attractive option for retirees.

Popular International ETFs:

• Vanguard FTSE Developed Markets ETF (VEA)
• iShares MSCI Emerging Markets ETF (EEM)

2. Mutual Funds

Mutual funds provide international exposure by pooling investments from multiple investors to buy a basket of international stocks. This offers diversification across various companies and sectors. Mutual funds are generally actively managed, which means fund managers make investment decisions to try to outperform the market.

Mutual funds can be beneficial for retirees seeking professional management, but they often come with higher fees compared to ETFs.

3. American Depositary Receipts (ADRs)

ADRs are certificates representing shares of foreign companies, traded on U.S. exchanges. Investing in ADRs allows you to buy international stocks without needing to deal with foreign exchanges, making them more accessible and convenient.

Popular ADRs Include:

• Toyota Motor Corporation (TM)
• Nestlé S.A. (NSRGY)

Tax Considerations for International Investments

Investing internationally also means dealing with unique tax considerations. For example, many countries impose withholding taxes on dividends paid to foreign investors. Tax treaties between the U.S. and other countries may help reduce these rates, but it’s important to consult a tax advisor to understand your obligations.

Historical Performance of U.S. vs. International Markets

Throughout the past century, there have been distinct periods when the U.S. market, represented by the S&P 500, has outperformed international markets, and vice versa. Understanding these trends can help highlight the value of diversification.

The 1980s: U.S. Outperformance

During the 1980s, the U.S. market experienced strong growth due to economic policies that encouraged deregulation and business expansion. The S&P 500 significantly outperformed many international markets during this decade, making it a favorable period for U.S.-focused investors.

The 2000s: International Outperformance

In contrast, the early 2000s saw international markets outperform the U.S. market. During this period, emerging markets like China and India experienced rapid growth, while the U.S. dealt with the aftermath of the dot-com bubble and the financial crisis. Investors who had exposure to international stocks, particularly in emerging markets, enjoyed superior returns compared to those solely invested in the U.S.

The 2010s: U.S. Dominance Again

The 2010s marked another period of U.S. outperformance. Fueled by the growth of technology giants and a strong economic recovery following the Great Recession, the S&P 500 outpaced many international indices. However, this decade also highlighted the risks of relying too heavily on a single market for returns.

Image source: Vanguard (https://www.vanguard.com/pdf/ISGGEB.pdf)

Lessons for Investors

These historical trends demonstrate that no single market consistently outperforms over time. By diversifying across both U.S. and international markets, you can reduce the risk of missing out on periods of strong growth in either region. Diversification provides the opportunity to benefit regardless of which market is leading in any given decade.

Strategies for Adding International Stocks to Your Portfolio

1. Determine Your Allocation

A common question retirees ask is: "How much of my portfolio should be in international stocks?" While the answer depends on your risk tolerance and financial goals, a general recommendation is to allocate between 10% and 20% of your retirement portfolio to international equities.

2. Diversify Across Regions and Sectors

When investing internationally, it’s important to diversify across different regions and sectors. For instance, consider mixing exposure to developed and emerging markets to strike a balance between risk and return.

3. Use Dollar-Cost Averaging

Instead of investing a lump sum, consider dollar-cost averaging. This means consistently investing a set amount over time, which can help reduce the impact of market volatility and lower your overall cost.

4. Monitor Global Trends

Keep an eye on global economic trends, political developments, and currency movements, as they can have a direct impact on your international investments. Staying informed will help you make timely adjustments and avoid potential pitfalls.

Balancing Risks and Rewards

The decision to add international stocks to your retirement portfolio is not without challenges, but the potential rewards make it a worthwhile consideration. By diversifying globally, you can improve the resilience of your portfolio, capitalize on growth opportunities beyond U.S. borders, and reduce your overall risk exposure.

However, it’s essential to approach international investing with a clear understanding of the risks involved. Consider working with a financial advisor to develop a strategy tailored to your needs, keeping in mind your risk tolerance, time horizon, and overall financial goals.

By diversifying your retirement portfolio with international stocks, you could potentially receive a higher rate of return while at the same time reducing your potential portfolio risk. Although this cannot be guaranteed. 

Demographics suggest that structural changes are occurring in other parts of the world which will result in the broadening of technological and business frontiers well beyond our backyard. 

We suggest investing anywhere from 10% to 20% of your retirement portfolio in international stocks. 

If you want to know more about adding international stocks to your retirement portfolio, be sure to consult with a financial planner. With the right allocation, international stocks can play a big role in your overall wealth-building goals. 

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