Financial planners often explain that diversification is important. That's pretty easy to grasp when you think about the saying, "Don't put all of your eggs in one basket." But, when it comes to investing, a lot of investors do just that by only investing in U.S. stocks. iShares Core MSCI EAFE ETF (IEFA +1.36%) can help you fix that quickly and easily!
The United States is important, but it's not everything
At roughly 25% of the world's gross domestic product (GDP), the United States is, by far, the most important market in the world. It also happens to be one of the most developed from a financial perspective. The regulations and size of the U.S. market make it a relatively safe place to invest, or as safe as financial markets can be, anyway. There are plenty of good reasons why investors place a heavy emphasis on investing in the United States.
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However, 25% of global GDP means that you are missing a lot of the world if you only invest in the United States. In this way, your portfolio could be lacking foreign exposure. And that is a potential diversification issue. By investing only in U.S. stocks, you are, effectively, putting all of your eggs in one basket. There are two notable problems with this.
First, if something happens to the U.S. market (a domestic recession, for example), you could end up with more financial pain than you expected. Second, you could miss out on the growth of foreign countries. Addressing both of those issues could help enhance your returns over time if you have or add some foreign exposure to your portfolio. To be fair, it isn't the end of the world if you don't have foreign exposure, but it is probably a good idea to add some.
iShares Core MSCI EAFE ETF: Dipping your toes into foreign waters
One way to invest in foreign markets is to buy foreign stocks listed on U.S. exchanges. That's not a bad plan, but it would logically require as much, if not more, work as adding additional stocks to your existing portfolio. Another way to go, and a much easier way, is to simply buy an exchange-traded fund (ETF) dedicated to investing in foreign markets.
There are two broad flavors of foreign countries: developed and developing. Developing markets tend to be the riskier option because they often lack the size and regulation of developed markets. For most investors just getting started with foreign stocks, it is a good idea to stick to more developed markets.
And that is exactly what iShares Core MSCI EAFE ETF offers in one quick investment. This ETF is market-cap weighted so that the largest companies have the biggest impact on its performance. But that also means you get exposure to big and important foreign companies. That said, it has exposure to companies that are small and medium-sized, too; they just have less of an impact on overall performance.
The country list is probably the most important fact here, though. EAFE stands for Europe, Australasia, and the Far East. Thus, iShares Core MSCI EAFE ETF specifically invests in Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom.
If you look at the country names, the key takeaway is that they are all well-developed markets. Past performance is no guarantee of future results, but if you want to get started with foreign investing, these are probably the countries that you'd want to be pulling from. The only notable missing link might be China, the second-largest economy in the world at around 18% of global GDP. Missing out on China, which is still considered a developing market by many investors, probably isn't enough of a reason to avoid iShares Core MSCI EAFE ETF.
iShares Core MSCI EAFE ETF is a very cost-effective choice, as well, given its tiny 0.07% expense ratio. Still, as with most broad-based index-tracking ETFs, you have to accept that you will never beat the market because you effectively own the market (or at least most of the developed foreign markets). The point of this ETF isn't to make shockingly large gains; it is to increase your foreign exposure while putting in the least amount of effort. And it achieves that very well.
How much should you invest in iShares MSCI EAFE ETF?
Here's the dilemma with investing in foreign markets: You want exposure to them but not too much exposure. The United States is still the place to be when it comes to finance, which is why so many foreign companies list on U.S. exchanges. Putting 75% of your portfolio (which global GDP statistics would suggest is an appropriate allocation) into an ETF like iShares MSCI EAFE ETF would leave you lopsided in a potentially troubling way.
To start, you might consider up to 25% of your equity-dedicated assets. Or, perhaps you grow up to that figure over time if foreign investing is new to you. The real goal is to add some additional diversification to the mix, and iShares MSCI EAFE ETF can do that quickly and easily. If you can get comfortable with this ETF, then you might even consider adding some developing markets to the mix.
