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Why to Invest More Than One-Fifth in International ETFs

Some well-publicized research indicates that an 80-percent-or-so domestic stock/20-percent-or-so foreign stock portfolio is optimal for maximizing return and minimizing risk with your ETFs. But almost all that research defines domestic stock as the S&P 500 and foreign stock as the MSCI EAFE. The MSCI EAFE is an index of mostly large companies in the developed world. (MSCI EAFE stands for Morgan Stanley Capital International: Europe, Australasia, and Far East.)

This analysis takes little account of the fact that you are not limiting yourself to the S&P 500 or to the MSCI EAFE. In the real world, you have the option of adding many asset classes to your portfolio of U.S. stocks.

Among your international holdings, you can also include developed world stocks in Europe, Australia, and Japan; emerging market stocks in China, India, and elsewhere; and foreign stocks in any and all flavors of large, small, value, and growth.

Many investment pros know well that they favor a much larger international position than they publicly advocate. Some may be afraid of seeming unpatriotic. Much more prevalent is a certain lemming-over-the-cliff-cover-my-ass mentality.

If your financial advisor suggests a portfolio that resembles the S&P 500 and your portfolio tanks, you’ll feel a bit peeved but you won’t hate him because all your friends’ and neighbors’ portfolios will have sunk as well.

Should he give you a portfolio that’s 50 percent foreign, and should foreign stocks have a bad year, you’ll compare your portfolio to your friends’ and neighbors’ portfolios, and you may hate him. You may even sue him.

Most investment professionals wouldn’t want that. So most err on the side of caution and give you a portfolio that’s more S&P 500 and less foreign — for their own protection, and not in the pursuit of your best interests.

By mixing and matching your domestic ETFs with 40 to 50 percent international, you will find your investment sweet spot. Time and time again, the most sophisticated (and perhaps most expensive) professional portfolio analysis software available indicates that 40-to-50-percent foreign is produces the highest returns per unit of risk. And yes, this range has worked very well in the real world, too.

Although the markets are so incredibly unpredictable, if you had to err on the side of either U.S. or foreign stock investment, err on the side of too much foreign. The world economic and political climate is indicating that the U.S. stock market may be on relatively shakier ground.

There is a long list of reasons (raging federal deficit and debt, trade deficit, aging population, military overextension, healthcare crisis) why the U.S. stock market may be riskier, but what’s most troubling about the United States is the extent to which it is becoming a nation of haves and have-nots. If history reveals anything, it is that great inequality leads to great dissension and upheaval.

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