Considering Investments in Foreign Stocks

Jonathan Clements, personal finance columnist for The Wall Street Journal, discusses investing in foreign stocks. Clements says investors can use foreign markets to diversify their investments and limit risk.

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STEVE INSKEEP, host:

On Fridays, the business report focuses on your money.

Americans are putting more of their money in foreign stocks these day, but Jonathan Clements thinks people still do not invest enough overseas. He's the personal finance columnist for The Wall Street Journal and he joins us once again.

Good morning.

Mr. JONATHAN CLEMENTS (The Wall Street Journal): It's great to be with you, Steve.

INSKEEP: OK. You're making this argument that people should put more money in foreign stocks. Why?

Mr. CLEMENTS: Well, what we've seen over the last three and a half years is there has been a dramatic increase in the amount that people are putting abroad. We went in the past three and a half years to something like 12 1/2 percent of stock mutual fund assets in global and international funds to something like 16 1/2 percent today. So we're definitely moving in the right direction. But I would argue that people should think about having 25 to 30 percent of their stock market money invested in foreign stocks, and the reason is this. When you invest abroad, what you can do is reduce the risk of your portfolio. And that might sound counterintuitive. I mean, people look at foreign stocks and say, `My goodness, they're so risky. They bounce up and down much more in price than US stocks. If anything, I want to own less of these.' What happens is that because US stocks and foreign stocks tend to move in different cycles--sometimes US stocks are up, foreign stocks are down. Sometimes it's vice versa. By putting the two together, you can lower the risk of your overall portfolio. And as a consequence, you know, you can get the same return at a lower level of risk.

INSKEEP: It becomes a hedge, in effect.

Mr. CLEMENTS: It's a very effective hedge. Just look at 2004. People say, `All right, 2004. Why should I invest in foreign stocks? I mean, both US and foreign stocks are up. There was no benefit to diversifying abroad.' But, in fact, in 2004, while the US stock market was up only 10, foreign stocks were u over 20 and some parts of the foreign markets, like emerging markets and small company stocks in foreign markets, did even better than that.

INSKEEP: What are some parts of the world to aim for if you're thinking about investing overseas?

Mr. CLEMENTS: Well, if you're going to invest abroad, the first thing you want to do is invest in mutual funds and avoid individual stock. And when you look at foreign stock funds, I would really try and think about them in three categories. Your core foreign stock holdings should be one of these funds that invests in the big companies in Germany, Japan, the UK, France, you know, the blue-chips stocks. But in addition, I would argue that today you should really consider adding two other foreign stocks funds, one that invests in smaller company stocks in these foreign markets, and, second, you really want to have an emerging-market stock fund there.

INSKEEP: What are the risks? What are the pitfalls to avoid here?

Mr. CLEMENTS: You know, when you build this portfolio, what you want to do is focus on the overall performance. For instance, take emerging markets. I mean, emerging markets are wild performers. In fact, I say to people, you know, `If you're going to invest in an emerging-market stock fund, for goodness sake, just look at the results every December 31st and that's it, because that way, you know, you'll only have one sleepless night a year.'

INSKEEP: Isn't there an additional risk here simply because the value of the dollar can move and completely scramble your investments?

Mr. CLEMENTS: You actually want that dollar exposure, because it's an additional way, a reason why foreign stock funds may perform differently from the US market. I mean, for instance, one of the reasons that foreign funds did so well in 2004 is because the dollar weakened. That increased the value of foreign stocks for US holders and, as a consequence, it boosted the performance of those foreign stock funds. This year, the US dollar has actually strengthened somewhat and, as a consequence, you know, foreign funds are a little bit behind the US market. But you want that diversification benefit, because the dollar helps with this smoothing out of your portfolio's performance.

INSKEEP: Jonathan Clements of The Wall Street Journal. Good to speak with you.

Mr. CLEMENTS: It's been great, Steve.

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