Rather than trying to pick individual stocks in far-off places, an easy way to add foreign assets to your portfolio is by investing in index funds that track specific groups of stocks or bonds. The two most popular classifications for these types of funds are developed markets and emerging markets.
Developed markets and emerging markets funds are popular offerings in 401(k) plans and among the investment choices offered by robo-advisors. While developed markets and emerging markets funds are different, they can be used in combination in your portfolio. Here's what you need to know.
The overseers of stock and bond indexes determine whether a specific country is considered to be a developed market or emerging market based on criteria like:
- How advanced its economy is
- The size of companies based there
- How easy it is for foreigners to invest
Many exchange-traded funds (ETFs) then track these indexes, making it easy for investors to quickly and affordably invest in a basket of assets from other countries.
Video by Jason Armesto
If you think about the countries that have long been the world's powers, they're probably among those considered to be developed markets. Examples include: Australia, Canada, Germany, and the United Kingdom. Oftentimes, these index funds are designed for U.S.-based investors, so they exclude companies based in the United States.
Emerging markets are those countries that don't yet meet all the criteria of the developed economies. These may be among the fastest-growing economies in the world, including: Brazil, Mexico, South Africa, and China.
Looking at the long-term returns for the U.S. stock market versus a developed or emerging markets fund, you may be tempted to stay at home with your investments.
For example, over the past 10 years, the S&P 500 delivered returns that were more than 10 times that of the largest ETF by assets that tracks developed markets — the Vanguard FTSE Developed Markets ETF. That's in part because the past decade has been one of the best ever for U.S. investors. But in 2009 and over the past year, the Vanguard developed markets fund performed comparably to, or even better than, the S&P 500.
All the same, it's important to remember the disclosure of all investment advisors: Past performance is no guarantee of future results.
The reason geography matters so much with investing is that the economies of various countries grow at different paces at any given time. By mixing up the combo of domestic versus foreign assets — one of the most popular ways to diversify your portfolio — you can help to balance out your overall risk and returns.
According to ETF.com, there are currently 250-plus ETFs that specifically track developed or emerging markets — and some of these funds focus on bonds rather than stocks, or specific industries or company sizes within these categorizations.
Finally, the best reason to consider adding these types of funds to your portfolio is because you can get all the benefits of diversification without having to do the legwork of trying to pick funds, or even individual stocks, that track specific countries.
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