Investing in international ETFs: A primer

What are international stocks?

From a U.S. point of view, international stocks are simply those that are not traded on U.S.-based exchanges such as the NYSE or NASDAQ, hence the term "ex-U.S.." They can broadly be categorized into two different markets:

1. International Developed: Consists of countries like Japan, the U.K., Canada, France, Switzerland, Australia, Germany, Korea, Netherlands, Sweden, Denmark, Spain, Italy, Singapore, etc. 
2. International Emerging: Consists of countries like China, Taiwan, India, Brazil, Saudi Arabia, South Africa, Mexico, Thailand, Indonesia, Malaysia, United Arab Emirates, Kuwait, Philippines, Chile, etc. 

Why international stocks?

The reason for diversifying some portion of your portfolio's equity allocation (usually anywhere from 20% - 40%) are numerous:

1. Mitigating the risk of the U.S. experiencing a long period of underperformance, such as what happened from 2001 – 2009 (the "lost decade").
2. Taking advantage of lower valuations for international stocks compared to U.S. ones. 
3. Lower correlations to the U.S. market for international stocks, which improves risk-adjusted returns. 

The simple argument though is to avoid performance chasing and succumbing to recency bias. There have been numerous times where other countries' stock markets (Australia, South Africa) continually outperformed the U.S., yet hardly anybody advocates for investing 100% in those markets. 

So why the U.S. only? I think the recent generation of investors only remembers the last 10 years of U.S. outperformance, which cannot last forever. Winners rotate, and reversion to the mean is a very real phenomenon. We all know past performance doesn't predict future performance, so why point to the recent U.S. outperformance as a reason to double down?

International ETF options

There are numerous types of international ETFs out there. As with all ETFs, the ones with the lowest expense ratios and highest assets under management (AUM) are generally good picks, especially if they're from a reputable fund manager. 

Investors have the ability to invest in the ex-U.S. market as a whole or break their picks down by developed vs. emerging. Many of these ETF pairs can serve as tax-loss harvesting pairs for each other given that they track different indexes. 

Ex-U.S. as a whole:

• Vanguard Total International Stock ETF (VXUS): 0.07% expense ratio. 
• iShares Core MSCI Total International Stock ETF (IXUS): 0.07% expense ratio. 

International developed:

• Vanguard FTSE Developed Markets ETF (VEA): 0.05% expense ratio. 
• iShares Core MSCI International Developed Markets ETF (IDEV): 0.04% expense ratio. 

International emerging:

• Vanguard FTSE Emerging Markets ETF (VWO): 0.08% expense ratio.
• iShares MSCI Emerging Markets Index ETF (EEM): 0.68% expense ratio. 

Most international equity ETFs are market-cap weighted, meaning that large-cap stocks tend to dominate the holdings. Investors who want to take on more risk for potentially more return have the option of targeting small-cap stocks, in particular small-cap value:

1. Avantis International Small-Cap Value ETF (AVDV): 0.36% expense ratio. 
2. Dimensional International Small-Cap Value ETF (DISV): 0.42% expense ratio. 

Finally, totally hands-off passive investors who want a one-ticket solution to holding U.S. and international stocks at their natural market cap weights can use the Vanguard Total World Stock ETF (VT), which is currently around 55/45 U.S. vs. international.