(MoneyWatch) Just a few years ago, during the height of the U.S. financial crisis, I was getting questions from lots of people wondering why they should own any U.S. stocks. Now, with all the financial problems plaguing Europe, many investors want to know if they should run from international stocks. The basic complaint is that they don’t see how international stocks would provide additional return or safety in their portfolios. So let’s address the concerns now being raised.
Risk and expected return are related
First, the most basic premise of finance is that risk and expected returns are positively related. If an investment is riskier, it should have higher expected returns. Thus, it’s not logical that U.S. stocks should be viewed as both safer while providing higher expected returns.
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International stocks have better expected returns
Second, while it now seems that international stocks (at least European ones) are riskier, all one has to do is to check some basic metrics to see whether they have higher or lower expected returns than U.S. stocks. We can do this by using Morningstar’s data and checking the metrics of Vanguard’s U.S. Total Stock Market Index Fund (VTMSX) and Total International Stock Index Fund (VGTSX). What we find is what we should expect to find: International stocks are priced to provide much higher returns. (Data is as of March 31.)