Does the Trump economy have you on edge? Send money overseas, using this sortable list of Best Buys in international funds.
For most of the 21st century, investors have been in love with the U.S. and lacking a motive to send money abroad. This year they have, for some reason, changed their thinking. So far foreign stocks are up 9% (dividends included), U.S. stocks down 5%.
If you want to join the flight overseas, use this guide to cost-effective index funds. They all have expenses no higher than 0.16% ($16 a year per $10,000), assets of at least $50 million and, with four exceptions, very diversified portfolios containing at least 100 stocks.
Counting all share classes, investors looking for U.S.-registered funds devoted to foreign stocks have 3,320 choices. Picking through that heap is an all-day task. Your work is simplified here with a roster of 48 Best Buys, all in the newer exchange-traded format, which means they can be acquired and held at any brokerage firm.
The list is sortable. Sort by average market capitalization if you want just large or just small companies, by yield if that matters to you or by any other column.
Here are things to contemplate while investing.
1. Do expenses matter?
Yes. Lots of foreign funds charge 2% or more, including the money handed over to the stockbrokers for persuading you to buy these funds. Continuing that kind of damage over a working lifetime will cut your retirement wealth in half.
Over the same period, a fund charging 0.05% will cost you a cumulative 2%.
2. Does performance matter?
Future returns matter a lot, but there’s no way to know them. So we are necessarily talking about past performance. The question is whether terrific past performance of a money manager makes up for a bad expense ratio. The answer: almost never.
Consider this disparity: Over the past decade, large foreign stocks have beaten small ones. This doesn’t tell you that large stocks are the better investment now. Maybe what you are witnessing is that small stocks have gotten too cheap and are now about to catch up.
A naïve investor will say, “I don’t care if my money manager charges 2%. He is beating the market by 5%, so I’m still 3% ahead.”
Wrong tense. There is no “is beating.” There is only “has beaten.” And past performance is only a faint indicator of future performance.
3. How are dividends on foreign stocks taxed?
Usually at some rate worse than the rate on U.S. dividends but better than the rate on U.S. bond interest.
Foreign dividends collected by U.S. citizens are first taxed in the payer’s home country, typically at a 15% rate, and then by the U.S. If your foreign fund is held in a taxable account, you can recover some or all of the foreign tax via a credit against your U.S. tax bill.
How much of those foreign taxes you can recover depends on some insanely complicated formulas described here.
Let’s suppose you are able to get back two-thirds of the foreign tax as a credit, and that you are in the 15% U.S. bracket for dividends. Then your combined tax rate is 20% (15% plus 15% minus 10%). That’s worse than the 15% rate you owe on most U.S. dividends but not as bad as the 24% rate you might be paying on interest income.
If the foreign stock fund is in a tax-sheltered account, the 15% lost to foreign tax collectors is not recoverable. That, by itself, is not a reason to keep the foreign investments outside the shelter. Outside, they incur the same 15% foreign levy plus, usually, some incremental U.S. tax (whatever is not offset by the credit).
Rule of thumb: Use space in your IRA and 401(k) first to hold your fixed income investments, next to hold foreign stock funds. U.S. stocks are last in line to go behind the shelter.
4. Are yields good on foreign stock funds?
Well, they are fat. That doesn’t make them good.
The 3.1% yield on the Vanguard Total International Stock Fund is better than double the 1.2% yield on the fund’s U.S. counterpart. But you would be better off with lower dividends abroad and higher capital gains. The appreciation is taxed only when you sell and doesn’t incur a tax by the foreign government.
If you need steady cash in retirement, dividends are not the only way to get it. To draw 3% from a portfolio yielding 1.2%, cash in the dividends and also 1.8% of the shares.
5. Are emerging markets a good place to put money?
Over the past decade they were a terrible place to invest. Now the stocks in countries like China, Brazil and India are cheap, trading at roughly half the multiples of earnings seen in the U.S.
Research Affiliates, a large money manager with a passive-adjacent strategy, puts out 10-year forecasts of real annual returns (dividends added, inflation subtracted). It has large U.S. growth stocks, the ones that have done best over the past decade, down for -0.5%, emerging market value stocks at +7.9%.
But “emerging” is a euphemism for “worrisome.” The Russian market once offered a tempting collection of cheap banks and oil producers. The iShares Russia ETF is now in the midst of an inglorious liquidation.
Most emerging-market funds have a large allocation to China (Vanguard’s is 29%), although there’s one China-free option on our list. Do you really want to bet on an economy overseen by a tyrant? What motivated you to look overseas to begin with?
6. Which is better, a mutual fund or an exchange-traded one?
If you are already doing business at Fidelity, Schwab or Vanguard, it might make sense to buy the house-brand, no-load mutual fund available there. Fidelity Zero is a good choice for an international mutual fund. Vanguard’s mutual funds are often copycats of its ETFs but with a slightly higher expense ratio.
A no-load mutual fund has no transaction cost, while going in and out of an ETF costs you the bid/ask spread. The spread comes to $1.60 on a $10,000 trade at Vanguard Total International Stock Index, the largest foreign ETF. The transaction cost can be stiffer at smaller ETFs.
For most investors, though, ETFs are better, for three reasons.
First is that long-term holders do better paying the transaction cost just once by buying an ETF. At a mutual fund, impatient investors get a free ride going in and out, imposing their trading cost damage on fellow shareholders and nibbbling away on everyone’s long-term return.
Next is that ETFs are very portable from one brokerage account to another. In contrast, a new broker might not be willing to hold a mutual fund run by a rival firm. You might be forced to liquidate and pay tax on the appreciation.
Last is that ETFs are better at tax time. Mutual funds often disgorge unwanted capital gain dividends on holders, while ETFs rarely do. If you are holding the foreign ETF in a tax-sheltered account, of course, this consideration does not apply.
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