There are a few reasons why investing abroad may be a good idea. The first is that historically it has been a good way of improving your risk-adjusted return. That is to say, investing in international stocks could give you better results over time, without taking on a lot more risk. Another plus is that international markets have over time had a lower correlation to large-cap U.S. indexes such as the S&P 500 than domestic small- and mid-cap stocks. This means that your international stocks aren't tightly linked to the returns of what is likely the core of your portfolio. Finally, international stocks can be a hedge against inflation at home or a falling dollar.
Of course, there are downsides and risks to investing aboard, as well. Frontier and emerging-market stocks are much more volatile than domestic stocks or those in other developed markets. For example, funds invested in China, Brazil, and other markets can have double the volatility of the S&P 500.
Political risk is another issue that investors should grapple with before jumping in. If a country were to implement currency controls or otherwise block foreign capital from entering the stock market, the value of your investment could suddenly drop.
So if after weighing the pros and cons of international investing you decided to dive in, why might ETFs be a good way to do so? First off, international ETFs have the same attributes that make ETFs attractive investments in other venues. They are generally easy to use, liquid, transparent, and tax efficient. International ETFs are also generally cheaper than their open-end counterparts.
ETFs also give investors a wide breadth of choices to gain access to different markets. There are international ETFs that slice the market by geography (global, regional, and single country), market-cap, investment style, sector, and even investment themes (China Infrastructure). Buying these broader instruments can be much easier than trying to construct a portfolio on your own.
With all of these options it is critical that you understand what you are buying, and that the investment actually aligns with your investment objectives.
Take for example two funds that sound very similar but are likely to have very different returns. For example iShares MSCI EAFE Small Cap Index Fund (SCZ) and Vanguard FTSE All-World ex-US Small Cap ETF (VSS) may seem similar at first glance, but the former doesn't include emerging market stocks, whereas the latter one does.
Reading the Morningstar ETF Analyst report can help you sort our exactly what the ETF holds and if it meets your goals.
You should keep a close eye on trading costs. These expenses can easily weigh down investment returns. Choosing funds that are more liquid, using limit orders, trading on days when the overall market is less volatile, and, when possible, trading an ETF when its underlying holdings (the foreign ordinaries) are trading can help minimize costs.
International ETFs can make a good addition to your portfolio. Just make sure you know what you own, that you understand the potential for much greater volatility in emerging- and frontier-market funds and that you keep trading costs to a bare minimum.