Your Nonstop Flight to Developed and Emerging Markets

When many young investors begin investing, they’re often told to consider U.S. stock funds. And for good reason. These funds tend to be low cost, have great diversification, and offer high returns in the long term. However, a well-diversified portfolio would include more than a U.S. stock fund.

Consider diversifying with international stocks, says Morningstar’s director of personal finance Christine Benz. The consensus view is foreign stocks are more attractively valued than domestic stocks now, and on average, they offer higher dividend yields compared with U.S. stocks. There are also great companies located abroad you otherwise wouldn’t have exposure to.

If you want to invest in foreign stocks, how should you go about doing so? A good place to start is understanding two different types: stocks from developed and emerging markets.

What are Developed Markets? Developed markets are countries with industrialized economies, strong political and legal systems, and robust technological infrastructures. These countries tend to have higher income per capita and less wealth inequality. The United Kingdom, Australia, and Japan are a few examples. Companies in these markets are more likely to be established, stable businesses. A few familiar stocks include Switzerland-based Nestle NSRGF, Canada-based Shopify SHOP, and Japan-based Toyota TOYOF.

What are Emerging Markets? Emerging markets are countries transitioning into industrial, modern economies--often at a rapid pace. They have less-stable political and legal systems than developed markets, however, and while their economies may be growing rapidly, that growth may not have reached average families. China, India, Russia, and Brazil are a few examples of emerging markets. Stocks from these investments tend to be riskier than their developed counterparts. A couple familiar stocks include China-based Tencent TCEHY and Alibaba BABA.

Developed, Emerging, or Both? Long-term investors should consider owning both developed- and emerging-markets stocks. As with domestic stocks, investing through a mutual fund or exchange-traded fund is a safer route, and many international stock funds provide broad diversification. For example, the iShares Core MSCI Total International Stock ETF IXUS has 78% of assets in developed markets and 21% of assets in emerging markets, reflecting these markets' percentage of the overall global stock market.

If you can't purchase an international stock fund that combines both developed and emerging markets, you can consider separate funds with exposure to each market. To avoid making active bets on certain regions--which requires the level of research and insight that individual stock-picking does--you can keep your portfolio's regional allocation in line with broader international stocks indexes. For example, the Morningstar Global Markets ex-US Index has nearly 4 times the amount in developed stocks as it does emerging stocks.

Ripe for Picking Choosing foreign stock index (passive) funds is the easier route: They're simple, low cost, and diversified. However, investors willing to do more research might consider actively managed foreign stock funds.

According to Morningstar research, actively managed foreign stock funds have more opportunity to beat the market than their U.S. stock fund counterparts. The global market is larger and more diverse than any one single country’s market, so managers have many tools at their disposal, including country and currency decisions, as well as industry and stock selection. And international stocks tend to be less widely researched than their domestic counterparts. These additional factors offer managers a greater opportunity to outperform their benchmarks.

Morningstar's Susan Dziubinski created a list of active and passive international stock funds that receive Morningstar Analyst Ratings of Gold.