International stocks have been on a hot streak this year, nearly doubling the return of their U.S. peers. With such a tempting return — about 14 percent for the first five months — is now the time to stock up on international equities?
Before answering this question, let’s first consider past performance. This chart shows international stocks were on fire from 2003 to 2007, but have been laggard in the past few years through the end of 2016. Since many now believe international stock valuations are more attractive than the U.S. equities, could this be the beginning of a period when international stocks outshine U.S. stocks?
I’m finding people are more receptive to my long-standing recommendation of having a third of their equities in international stocks than they were a year ago. Often they tell me they are concerned about the political turmoil in the United States, and they figure that the lackluster performance of international stocks in the past few years means they are now due to soar. Considering no one knows the future, these are the wrong reasons to own international stocks.
In my experience, people tend to rationalize why they buy an asset class that has recently done well. In 2007, for instance, as international stocks surged, it was a challenge to get clients to limit their exposure to these stocks. The sort of comments I heard then was something like, “Why only a third since nearly all of the growth is coming from overseas?” Last year was just the opposite mind-set. Persuading investors to own much in the way of international stocks was the challenge as concerns turned to all of the problems overseas such as Brexit.
Small investors — and even professionals — do chase performance. And they pay a price for their bad timing, says Russel Kinnel, director of manager research at Morningstar, an investment research company. His recent work shows that the typical investor has underperformed the average fund for the past decade. Sticking to an asset allocation strategy typically works better than making frequent changes.
I recommend owning international stocks for one reason — diversification. We live in a global economy, and investing globally is important. I live in Colorado and would never invest only in Colorado stocks, just like you shouldn’t invest only in stocks in your home state. But having a hunch that international stocks will outperform the U.S. market is the wrong reason to load up on them.
Last year, I made the case for including international stocks in one’s portfolio. I didn’t know they would do so well this year — or lag for the remainder of 2016 — and I still don’t today. I made no changes in my investing with President Trump since I don’t know anything that hasn’t been already priced into markets.
Committing to whatever asset allocation you decide is best for you is more important than whether your exposure to international stocks at this point is too high or too low. Sticking with an allocation means you likely will be buying low and selling high — the opposite direction of the herd.
Don’t buy international stocks because you think they will outperform. And don’t think you know which countries or sectors will do better unless you are certain you know something the market doesn’t already know. Do own international stocks because you want a disciplined approach to global diversification.
Allan Roth is the founder of Wealth Logic, an hourly based financial planning firm in Colorado Springs, Colo. He has taught investing and finance at universities and written for Money magazine, the Wall Street Journal and others. His contributions aren't meant to convey specific investment advice.