Similar to nutrition advice to "eat the rainbow," investors would do well to "invest around the world." And one way to do so is to find the best international ETFs (exchange-traded funds).
International exposure is a key element in creating a diversified portfolio to avoid home country bias, where you become overexposed to stocks domiciled in your home country. If you only invest domestically and your country experiences a recession, your entire portfolio could tank.
"It is imperative to have some international exposure in your investment portfolio as domestic markets and international markets are not always correlated when it comes to performance," says Ronnie Thompson, investment advisor representative and owner of True North Advisors. When your home country is in recession, other nations may be thriving and thus could balance out your portfolio.
One of the best ways to get international exposure is through an international ETF. These funds hold many different international stocks, allowing you to diversify even further within your global exposure. This also reduces the risk of putting all of your international eggs in a single foreign country's basket.
International ETFs can also be purchased on the U.S. stock exchange so you don't have to navigate foreign stock markets to access them.
But choosing the right international investments and appropriate degree of international exposure isn't always easy. You first need to understand why you're seeking exposure overseas, then know what to look for in the best international ETFs.
The importance of international exposure
In addition to helping diversify your portfolio, the best international ETFs can enable you to access better growth or value opportunities than those offered domestically.
"For example, emerging markets can give access to certain countries that are experiencing potentially greater growth than we have historically seen in mature economies, such as here in the United States," says Chris Huemmer, senior client portfolio manager at Northern Trust FlexShares. "Companies in these growth economies can potentially take advantage of better demographics, cheaper labor and access to natural resources to grow businesses both at home and abroad."
International equities are also often more attractively valued than those in the U.S. Valuations on international stocks have historically been lower than U.S. stocks, says Brian Kraus, senior vice president of Systematic ETFs at Hartford Funds. This gap is even larger now as the U.S. markets recovered faster than other markets, creating compelling opportunities for savvy investors.
"International stocks are also generally more cyclical and historically perform better in value cycles versus growth cycles, as they have about twice as much cyclical sector exposure as the S&P 500," Kraus says. "Current market dynamics are shifting in favor of value and if this continues to hold firm, we believe this may be beneficial to international stocks and funds."
How much international exposure to have
Before you can choose the best international ETFs, you need to know how much of your portfolio to allocate to foreign investments.
Unfortunately, there's no perfect mix of domestic to international stocks because the right amount will depend on your investment objective. However, Thompson says a decent rule of thumb for a traditional portfolio is to hold 60% domestic and 40% international. This "creates a good diversification, but also allows you to remain concentrated in U.S. based markets which, long-term, have always been strong," he says.
This also reflects the fact that international stocks make up around 40% of the global market capitalization across all stock markets.
"Often investors will mirror this percentage as a starting point with 40% of their overall equity allocation being earmarked for international stocks, and then adjusting that percentage up or down based on risk tolerances, investment preferences, time horizon or a myriad of other factors," Huemmer says.
How to find the best international ETFs
There are several best practices to keep in mind when choosing the best international ETFs. The most important characteristics to pay attention to in any foreign fund are its:
- Country exposure: "Each index provider may define the countries in their universe differently, which can lead to very different weightings on both a country and sector level," Huemmer says. "For example, the term 'world' may mean a different set of countries for each index provider," and some developed market indices exclude Canada from their universe.
- Expense ratio: International equity ETF expense ratios were on average 0.1% higher than U.S. equity ETFs in 2022, but you should still aim to keep expenses low.
- Tracking error: Many international ETFs track a benchmark index and the tracking error will measure how closely the fund adheres to its benchmark's performance.
While keeping investment costs low is important, Kraus cautions against blindly looking for opportunities in the cheapest parts of international markets.
"This simplistic approach toward lower portfolio valuations can result in exposure to companies with poorer profitability and elevated volatility," he says. Instead, look for "valuable opportunities within international markets, without sacrificing quality and consistency."
The best international ETFs
Before perusing the following list of some of the best ETFs with an international flavor, remember that what's "best" for one investor may not be best for another. Choose international ETFs as you would domestic ETFs: by finding the fund whose strategy will help you reach your own investment goals.
That said, here are three of the best international ETFs to consider adding to your portfolio:
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