Foreign markets have been one of the best performing areas in 2017. Could this be the start of a new trend?

Some respected market analysts believe that after eight years of a strong U.S. trend, markets are finally shifting away from the U.S. and toward overseas markets. But remember that even experts can’t always predict market trends in advance.

If you want to capitalize on foreign and emerging markets trends, here are four tips to help you adapt to changing markets and avoid common mistakes:

1. Rely on a proven strategy

If you’re going to try to take advantage of market trends, you’ll need a clear, evidence-based strategy, like our momentum-driven Upgrading approach, to help you determine when to own foreign and emerging markets funds and when U.S. funds are a better bet.

A solid strategy can help you avoid making common mistakes, like continuing to hold U.S. funds during a clear foreign trend because you’re convinced that they’re going to bounce back.

2. Make gradual changes to your portfolio

Trends build over time, and even within a confirmed trend, there are often short-term reversals, so try to buy into new leading funds, like foreign funds, gradually.

As foreign and emerging market funds began to do well, we introduced these funds to our portfolios, and as these funds continued to do well, we added to our positions. This way, if foreign markets were to reverse course only a part of our portfolio would be affected, and if foreign continues to lead, we’ll participate in the gains.

3. Stay diversified

Whether foreign or U.S. markets are in favor, you should be primarily invested in core diversified funds. Our rule of thumb is to own at least five of these funds.

Don’t get tempted to take shortcuts, like making a big bet on a few concentrated funds. Rather than investing in an emerging market fund, for instance, get your emerging market exposure through broadly diversified global or international funds. Oakmark International (OAKIX) or Dodge and Cox Global (DODWX) both have had strong recent returns, and these funds have 7-10% in emerging markets.

4. Manage risk by taking smaller positions in riskier funds

More speculative funds, like single country funds or emerging markets funds, can seem like a quick way to boost your returns, but these funds can fall out of favor just as quickly and they can have steep losses.

If you are going to invest in more volatile foreign funds, like single country funds or emerging markets funds, keep your positions small. This may help limit the damage if one of these funds suddenly drops. We might invest 10% in a broadly diversified fund, but just 5% in an emerging market fund, and we’d probably invest just 2% in a single country fund.

The takeaway here is that whether you are investing in the U.S. or overseas, you still need to think about how to manage potential risks and build a solid portfolio that can help you stay invested through the market’s usual ups and downs.

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How should you use foreign funds?

This is a question just about every investor should consider because there are years when foreign markets have had terrific returns, far outpacing U.S. stock funds.

When it comes to foreign investing, you have three choices:  

1. Avoid foreign investments altogether 

It’s natural for investors to have a home country bias, and you could just steer clear of foreign funds entirely and invest only in the U.S.

But foreign markets present tremendous opportunities. From 2003 through 2007, for example, the developed market EAFE index strongly outpaced the domestic S&P 500 index. When foreign markets are in favor, limiting your portfolio to only domestic funds can limit your returns.

2. Stay invested in foreign at all times

 You could keep a fixed part of your portfolio invested in international funds. This way, you’ll own foreign in years like 2003-2007 when overseas markets were the place to be. But you’ll also be stuck with those foreign funds when they are out of favor, sometimes for years at a time. This can be a real drag on your overall performance. For the past eight years, for example, U.S. markets have outpaced most foreign markets.

3. Adjust your foreign allocation over time to capitalize on market trends 

Foreign investing doesn’t have to be all or nothing. There are strategies like our Upgrading approach that have a proven track record of helping you invest internationally during sustained foreign trends and domestically when U.S. markets are bringing in stronger returns.

Upgrading Adapts to Foreign & Domestic Trends

Continue reading “How to Use Foreign Funds” »

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