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Why should investors have international stock exposure? Financial advisors recommend it and many take this advice for granted like you should eat less sugar. Let’s understand the real reasons for this advice.
International Stocks Are Back In Vogue
First, international stocks are back on investors’ radars. If you take any major international stock ETF like VXUS or SCHF, they outperformed the S&P 500 over the last 6 months.
The biggest contributing factor for this outperformance has been the declining US dollar. As investors pulled money out of US stocks and other assets, some of it went overseas. Also, Trump tariffs did not help either. Fears of the US economic slowdown contributed to the selloff. The US dollar declined by over 8% since the beginning of the year to the end of May of 2025.
If you are living in the US, the chances are high that you are overweight on US stocks. And rightfully, you would say “so what”? If we zoom out, the S&P 500 beat all international stock funds many times over the last 10 years.
So, why would you have international exposure at all at this stage when US stocks are on fire. Let’s begin by looking at a history of how US vs. international stocks perform over the last 40-50 years.
Cyclicality of US vs. International Stocks Returns
This table below shows how the S&P 500 index performed relative to its foreign peers.
The first thing to observe is that US vs. foreign equities performance fluctuates every 5 to 10 years. In the 80s, it was international stocks that shined. There was raging inflation and other monetary shocks in the US that led to this outperformance. But, the S&P 500 did so much better in the roaring 90s and, of course, more lately. If we extend the period to 2025, the outperformance of S&P 500 becomes staggering.
So, the first important lesson we learn from is that relative outperformance happens in cycles. Foreign stocks may follow different cycles vs. US stocks. This can be valuable and lead to better diversification outcomes in retirement. For someone in or nearing retirement, chasing performance becomes secondary. Most people in or nearing retirement think about smoothing out and creating consistency in returns.
Second, most of the outperformance of US stocks that we saw happened since 2009-2010. As tech stocks powered ahead, the US equity market grew to gargantuan proportions. The recent outperformance episode by US stocks is over 14 years long. That’s a lot by historic comparisons.
US Stocks Are Getting Pricier
Vanguard did an analysis on sources of the recent outperformance of US equities. US stocks outperformed international stocks by 7.50% from 2013 to 2023. Earnings growth and multiple expansion were the biggest contributors. Multiple expansion alone contributed almost 50% to this outperformance (or 3.30%). In other words, the US stock market got pricier.
Next, let’s look at the price-to-earnings ratio for US vs. developed international stocks.
This red line goes up if US stocks see higher P/E ratio expansion vs. foreign equities. Since 2010, US stocks saw their relative valuation multiple expand by over 50%. The question then becomes: how long can this runup last?
Of course, we don’t know where markets will move from here. But, what if someone is getting concerned about lofty valuations of US equities? Then, it could be a good time to diversify into foreign stocks. The biggest risk to anyone early into retirement is the sequence of returns risk. The risk comes into play when you are forced to sell shares at rock bottom prices for a prolonged period of time. With that, the risk of early portfolio depletion goes up.
The main issue with going all in on US stocks is this. An investor gets exposed to a narrow set of economic and market conditions of the USA. Foreign stocks can mitigate this issue. They do so by casting a wider net over multiple markets. Many economies have economic cycles and growth profiles different from the US. Recent outperformance of foreign stocks underscores the importance of this argument.
Currency Risk is Not So Bad for International Stocks
Now, let me address a few misconceptions about investing in foreign stocks. The first one is foreign currency risks. If you invest in international equities, you get exposed to forex fluctuations. But, the thing is that sometimes it is bad, sometimes it is good.
Most often, the US dollar follows where US assets performance goes. The US dollar tends to weaken when US assets underperform and vice versa. Morningstar looked at US dollar fluctuations and their effect on international returns. They concluded that their effect tends to wash out over the long-term.
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Take the iShares ETF family tracking foreign developed markets. iShares has both hedged and unhedged versions of it. If we compare their performance, the unhedged ETF outperformed the hedged one lately. Because the US dollar depreciated by over 8% over this period, it helped a lot.
Of course, we will find periods when the hedged version outperformed the unhedged one. That often happened when the US dollar strengthened, like it did in 2024. So, depending on where the dart lands, currency fluctuations may help or not.
US Companies’ Foreign Sales Make International Investing Outdated?
The other counter-argument against international exposure is this. Many US companies derive a large share of their revenues outside of the US. So, in a sense, you get foreign exposure with the S&P 500 anyways. For instance, the estimated S&P 500’s share of non-US revenues ranges from 30% to 40%.
True, this helps and I see where this counter-argument comes from. And, yet, I would point out a few holes in it. First, many American companies still convert their earnings to US dollars at the end of the day. And, many hedge their currency risks. But, as we saw earlier, currency fluctuations may help sometimes, as it did recently.
Second, at the end of the day, S&P 500 stocks still behave like a typical American stock. And many times it does not matter if a company has foreign sales. When the US stock market is down, the S&P 500 is down irrespective of its sales origin.
Conversely, foreign markets behaved in a different way for some of those days. And, that’s what an investor should care about. And, that is to find assets that don’t move in tandem with each other one for one.
Another issue with investing in US stocks only is that you will get too exposed to certain sectors. For instance, lately, the US stock market is overweight on tech. The technology sector accounts for over 30% of the total market. The financial and healthcare sectors are distant second and third. That’s not a bad thing by itself as it reflects where money and profits go. But, for a retiree who is not chasing performance, it could be a concern.
The foreign stock markets tend to be more value-oriented. The top three sectors are financials, industrials and tech. So, including international stocks can help you diversify sector allocations.
And finally, if you exclude foreign stocks, you won’t get exposure to some of the global leading companies. For instance, take ASML and TSMC. Although these stocks trade on Nasdaq and New York Stock Exchange, the S&P 500 excludes them. So does Vanguard Total Stock Market ETF (VTI). That’s because they are foreign companies. On top of it, I am not even speaking of other international stocks not trading on US stock markets.
How Much to Allocate to International Stocks?
With that aside, many investors wonder how much to allocate to foreign stocks. If we take the US stock market, its weight in global equities has fluctuated from 40% to 60%. Lately, it has been closer to 60%. So, 40% is a reasonable start.
If we look at Vanguard Total World Stock ETF (VT), it allocates roughly 40% to non-US equities. Vanguard did a study on global equity exposure. They noted that volatility starts to go up with foreign allocations above 35% to 55%. In other words, their conclusion is that an investor can capture most benefits from international exposure with about 40% allocation.
But, for some investors even 30% – 40% could be too much. At the end of the day, this is a personal choice. There are many fantastic international stock funds out there. One such fund is Vanguard Total International Stock Index Fund ETF (VXUS). It will allow you to allocate as much as you want to foreign stocks in a broad and diversified way.