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ETF Specialist

More-Palatable Approaches to Adding Foreign Fare to Your Plate

Foreign stocks can be riskier than their U.S. counterparts, but it is possible to mitigate this risk.

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Low-cost market-cap-weighted index funds can serve as the foundation of a strong portfolio. They effectively represent the collective views of all investors in a given market and should serve as a default for those who don't have an alternative opinion to express.  Vanguard Total Stock Market ETF (VTI) (0.05%),  Vanguard FTSE Developed Markets ETF (VEA) (0.09%), and  Vanguard FTSE Emerging Markets ETF (VWO) (0.15%) are among the cheapest options for broad, market-cap-weighted exposure to U.S., foreign developed-markets, and emerging-markets stocks, respectively. These three funds cover the full market-cap spectrum of their target markets and could form the nucleus of an equity portfolio. Foreign stocks tend to be riskier than their U.S. counterparts because they expose investors to greater currency risk. However, they should carry a significant weighting in a well-diversified portfolio.

Using the composition of the FTSE Global All Cap Index at the end of November 2015 as a point of reference, U.S. stocks represent 53% of the world's investable market capitalization. The corresponding figures for foreign developed-markets and emerging-markets stocks are 40% and 7%, respectively. Those who want to maintain a neutral regional allocation could use a fund like  Vanguard Total World Stock ETF (VT). But there are some advantages to retaining control over regional allocations rather than letting them fluctuate with market prices. This approach allows investors to maintain a more consistent level of portfolio risk (as stocks in each region have different risk characteristics) and rebalance opportunistically to take advantage of attractive valuations.

Alex Bryan has a position in the following securities mentioned above: EFAV, EEMV. Find out about Morningstar’s editorial policies.