International Diversification Basics

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What You’ll Learn

1. ✅ Understand why international diversification matters for U.S. investors
2. ✅ Learn the difference between developed and emerging markets
3. ✅ Determine your optimal international allocation (20%, 30%, 40%, or more?)
4. ✅ Choose between international stocks, ETFs, and ADRs
5. ✅ Understand currency risk and how it affects returns
6. ✅ Build a globally diversified portfolio from scratch
7. ✅ Avoid common international investing mistakes

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Why Invest Internationally?

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Reason #1: The U.S. is Only 60% of Global Markets

• 🇺🇸 United States: ~60% of global stock market
• 🌍 Rest of World: ~40% of global stock market

• Europe: ~15% (UK, Germany, France, Switzerland)
• Japan: ~6%
• China: ~5%
• Canada: ~3%
• Emerging Markets (other): ~8%
• Australia/Asia Pacific: ~3%

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Reason #2: Diversification Reduces Risk

• U.S. stocks vs. International stocks: ~0.70 correlation
• Meaning: They move in the same direction ~70% of the time, but diverge 30% of the time

• International outperforms during some periods
• U.S. outperforms during others
• Holding both = smoother overall returns

• 100% U.S. stocks: 15-18% annual volatility
• 80% U.S., 20% International: 14-16% volatility (slightly lower)
• 60% U.S., 40% International: 13-15% volatility (more reduction)

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Reason #3: Access to Unique Opportunities

• 🇨🇭 Swiss pharmaceuticals: Roche, Novartis
• 🇩🇪 German manufacturing: BMW, Siemens, SAP
• 🇯🇵 Japanese tech: Toyota, Sony, Nintendo
• 🇫🇷 French luxury: LVMH, Hermes, L’Oreal
• 🇬🇧 British banking: HSBC, Barclays
• 🇰🇷 Korean semiconductors: Samsung, SK Hynix

• 🇹🇼 Taiwan chips: TSMC (makes chips for Apple, NVIDIA)
• 🇨🇳 Chinese e-commerce: Alibaba, Tencent, JD.com
• 🇮🇳 Indian IT services: Infosys, TCS
• 🇧🇷 Brazilian commodities: Vale (iron ore), Petrobras (oil)

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Reason #4: Hedge Against U.S. Underperformance

• U.S. stocks (S&P 500): -9% total (lost decade!)
• International stocks (MSCI EAFE): +19% total
• Emerging Markets: +154% (crushed U.S.!)

• U.S. stocks: +257% (best decade ever)
• International stocks: +51% (lagged severely)
• Emerging Markets: +37%

• 2000-2010: You made 0% while international made 19-154%
• 2010-2020: You crushed it

• You captured BOTH periods (just not at maximum)
• Smoother, more consistent long-term returns

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Reason #5: Currency Diversification

• Your international investments go UP (foreign currency gains)
• Hedge against dollar decline

• You own European stocks worth €10,000
• EUR/USD = 1.10 ($11,000 value to you)
• Euro strengthens to 1.20
• Same €10,000 now worth $12,000 (even if stock price unchanged)
• You gained 9% from currency alone!

• When dollar strengthens, international stocks go DOWN (currency headwind)

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Developed Markets vs. Emerging Markets

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Developed Markets (EAFE)

• 🇯🇵 Japan (largest, ~20% of EAFE)
• 🇬🇧 United Kingdom (~12%)
• 🇫🇷 France (~9%)
• 🇨🇭 Switzerland (~8%)
• 🇩🇪 Germany (~7%)
• 🇦🇺 Australia (~6%)
• 🇨🇦 Canada (sometimes included)
• Plus: Netherlands, Spain, Italy, Sweden, Denmark, etc.

• Stability: Established economies, rule of law, property rights
• Returns: Moderate (7-9% long-term average)
• Volatility: Similar to U.S. (14-17% annual)
• Dividend yield: Higher than U.S. (2.5-3.5% vs. 1.5-2%)
• Growth: Slower than U.S./emerging markets (aging populations)

• VEA (Vanguard Developed Markets) - 0.05% expense ratio
• SCHF (Schwab International Equity) - 0.06%
• IEFA (iShares Core MSCI EAFE) - 0.07%
• EFA (iShares MSCI EAFE) - 0.33% (older, more expensive)

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Emerging Markets

• 🇨🇳 China (largest, ~30% of EM)
• 🇮🇳 India (~18%)
• 🇹🇼 Taiwan (~16%)
• 🇧🇷 Brazil (~5%)
• 🇸🇦 Saudi Arabia (~4%)
• 🇰🇷 South Korea (~12%)
• 🇲🇽 Mexico (~3%)
• Plus: South Africa, Indonesia, Thailand, Poland, Turkey, etc.

• Growth: High (emerging economies growing 4-7% GDP vs. U.S. 2-3%)
• Returns: Higher potential (10-12% long-term, but inconsistent)
• Volatility: MUCH higher (25-35% annual swings)
• Risk: Political instability, currency crashes, less regulation
• Dividend yield: Moderate (2-3%)

• VWO (Vanguard Emerging Markets) - 0.08% expense ratio
• IEMG (iShares Core MSCI Emerging Markets) - 0.09%
• SCHE (Schwab Emerging Markets Equity) - 0.11%
• EEM (iShares MSCI Emerging Markets) - 0.69% (older, expensive)

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Frontier Markets (Very Risky)

• Growth: Extremely high potential (7-10% GDP)
• Risk: VERY high (political, currency, liquidity)
• Volatility: Extreme (30-50% annual swings)
• Returns: Unpredictable (can boom or bust)

• FM (iShares MSCI Frontier & Select EM) - 0.79%

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How Much International Exposure?

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Common Allocation Approaches

• U.S. = 60% of global markets
• International = 40% of global markets
• Therefore: 60% U.S., 40% International

• $6,000 in VTI (U.S. stocks)
• $3,000 in VEA (Developed markets)
• $1,000 in VWO (Emerging markets)

“International allocation of 30-40% historically optimized risk-adjusted returns for U.S. investors.”

• $7,000 in VTI (U.S. stocks)
• $2,100 in VEA (Developed markets)
• $900 in VWO (Emerging markets)

• $7,500 in VTI (U.S. stocks)
• $1,750 in VEA (Developed markets)
• $750 in VWO (Emerging markets)

• $8,500 in VTI (U.S. stocks)
• $1,000 in VEA (Developed markets)
• $500 in VWO (Emerging markets)

• Holds 9,000+ stocks globally
• Automatically weights by market cap (~60% U.S., 40% international)
• Expense ratio: 0.07%
• One-fund portfolio!

• $10,000 in VT (Total world)

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Using Sage to Determine Your Allocation

Hey Sage, help me determine my optimal international allocation:

MY PROFILE:
- Age: [your age]
- Risk tolerance: [low / moderate / high]
- Investment horizon: [years]
- Current portfolio: [% U.S. stocks]
- Preference: [U.S.-focused / globally diversified / no strong preference]

Can you recommend:
1. What % should I allocate to international stocks?
2. How should I split between developed and emerging markets?
3. Specific ETFs to implement this allocation
4. Rationale for your recommendation

Make it personalized to MY situation.

Hey Sage, help me determine my optimal international allocation:

MY PROFILE:
- Age: 35
- Risk tolerance: Moderate to high
- Investment horizon: 30 years
- Current portfolio: 100% U.S. stocks (VTI)
- Preference: Want global diversification but not extreme

Can you recommend:
1. What % should I allocate to international stocks?
2. How should I split between developed and emerging markets?
3. Specific ETFs to implement this allocation
4. Rationale for your recommendation

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Implementing International Diversification

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Method #1: Using Broad International ETFs (Easiest)

• Holds both developed AND emerging markets (auto-weighted)
• 7,900+ stocks
• Expense ratio: 0.07%
• One-fund solution for international

• Buy $3,000 of VXUS
• Done! (Instant global diversification)

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Method #2: Separate Developed and Emerging (More Control)

• 75% Developed Markets (VEA)
• 25% Emerging Markets (VWO)

• Buy $2,250 VEA (developed)
• Buy $750 VWO (emerging)

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Method #3: Individual Country ETFs (Advanced)

• EWJ - Japan (iShares MSCI Japan) - 0.50%
• EWG - Germany (iShares MSCI Germany) - 0.51%
• EWU - United Kingdom (iShares MSCI UK) - 0.51%
• EWC - Canada (iShares MSCI Canada) - 0.51%
• MCHI - China (iShares MSCI China) - 0.57%
• INDA - India (iShares MSCI India) - 0.65%
• EWY - South Korea (iShares MSCI South Korea) - 0.59%
• EWZ - Brazil (iShares MSCI Brazil) - 0.59%

• $750 EWJ (Japan) - 25%
• $600 EWG (Germany) - 20%
• $450 EWU (UK) - 15%
• $450 MCHI (China) - 15%
• $450 INDA (India) - 15%
• $300 EWY (South Korea) - 10%

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Method #4: International Individual Stocks (ADRs)

• ASML (Netherlands - chip equipment)
• NVO (Novo Nordisk - Denmark - pharmaceuticals)
• SAP (Germany - enterprise software)
• LVMUY (LVMH - France - luxury goods)
• NESN (Nestle - Switzerland - consumer goods)

• TSM (Taiwan Semiconductor - chip manufacturing)
• BABA (Alibaba - China - e-commerce)
• SONY (Sony - Japan - consumer electronics)
• TCEHY (Tencent - China - tech/gaming)

• VALE (Vale - Brazil - mining)
• PBR (Petrobras - Brazil - oil)
• MELI (MercadoLibre - Argentina/LatAm - e-commerce)

• $500 TSM (Taiwan chips)
• $500 ASML (Netherlands chip equipment)
• $500 BABA (China e-commerce)
• $500 NVO (Denmark pharmaceuticals)
• $500 SAP (Germany software)
• $500 MELI (Latin America e-commerce)

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Currency Risk Explained

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What is Currency Risk?

1. Stock price change (same as U.S. stocks)
2. Currency exchange rate change (unique to international)

• BMW stock: €100
• EUR/USD exchange rate: 1.10
• Value to you (USD): $110

• BMW stock: €110 (+10%)
• EUR/USD exchange rate: 1.00 (Euro weakened)
• Value to you (USD): $110 (0% gain!)

• BMW stock: €110 (0% change)
• EUR/USD exchange rate: 1.20 (Euro strengthened)
• Value to you (USD): $132 (+20% gain!)

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Is Currency Risk Good or Bad?

• Hedges against dollar decline
• Different economies = different currency movements
• Over long term (20-30 years), currency effects average out

• Adds short-term unpredictability
• Can amplify losses (stock down + currency down = double whammy)
• Harder to predict returns

• Currency can add or subtract 5-15% annually to international returns
• Over 10+ years, usually ±0-2% annual impact (less significant)

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Should You Hedge Currency Risk?

• HEFA - Hedged developed markets
• DBEF - Hedged Europe
• DXJ - Hedged Japan

• Removes currency volatility
• Focuses purely on stock returns
• Can outperform during dollar strength

• Higher fees (0.30-0.50% vs. 0.05-0.10% unhedged)
• Misses currency gains when dollar weakens
• Reduces diversification benefit

“For long-term investors, currency hedging is generally not recommended. Costs outweigh benefits.”

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Tax Considerations

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Foreign Tax Credit

• French stock pays $100 dividend
• France withholds 25% tax = $25
• You receive $75

• Reduces your U.S. tax bill by amount of foreign taxes paid
• Recovered in most cases (for developed markets)

• Your broker reports foreign taxes on Form 1099-DIV
• Include Form 1116 with your tax return
• IRS credits you back (up to limits)

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Tax-Advantaged Accounts

• Foreign tax credit does NOT apply (no tax return for IRA)
• You LOSE the benefit of foreign tax credits

• Hold international stocks in TAXABLE accounts (claim foreign tax credit)
• Hold U.S. stocks in IRAs (no foreign tax to worry about)

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Common International Investing Mistakes

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Mistake #1: Home Country Bias (0% International)

• U.S. was worst-performing region 2000-2010 (-9% vs. +19% international)
• You would have made ZERO while international made double-digit returns

• Allocate at least 20-30% to international
• Don’t let patriotism override diversification
• Remember: Some of the world’s best companies aren’t American

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Mistake #2: Chasing Recent Performance

• 2010-2020: U.S. crushes international (+257% vs. +51%)
• 2021: You go 100% U.S. stocks
• 2022-2030: International outperforms (hypothetically)

• Leadership rotates every 10-15 years
• Chasing = buying high, selling low

• Set target allocation (e.g., 30% international)
• Stick to it regardless of recent performance
• Rebalance INTO underperformers (buy low)

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Mistake #3: Overweighting Emerging Markets

• Emerging markets are EXTREMELY volatile (50-70% crashes possible)
• Currency risk is amplified
• Political risk (government can seize assets, change rules)

• Chinese stocks (MCHI): -50% (regulatory crackdown)
• Destroyed portfolios overweight China

• Limit emerging markets to 20-30% of international allocation
• Or 5-10% of total portfolio
• Don’t bet the farm on high-growth = high-risk

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Mistake #4: Ignoring Fees

• $100,000 at 0.10$1.0M final value
• $100,000 at 0.70$840k final value
• High fees cost you $160,000!

• Use low-cost ETFs:
  • VEA (0.05%), VXUS (0.07%), VWO (0.08%)
• Avoid expensive actively managed international funds

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Mistake #5: Not Rebalancing

• Start: 70% U.S., 30% international
• 10 years pass, no rebalancing
• Now: 85% U.S., 15% international (U.S. outperformed)
• You’ve lost diversification benefit

• Rebalance annually or when drift exceeds 5%
• Sell U.S. winners, buy international losers
• Maintain target allocation

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Sample Globally Diversified Portfolios

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Conservative Global Portfolio (Age 55+)

• 35% VTI (U.S. stocks) = $35,000
• 15% VXUS (International stocks) = $15,000
• 10% SCHD (U.S. dividend stocks) = $10,000

• 30% BND (U.S. bonds) = $30,000
• 10% BNDX (International bonds) = $10,000

• Global diversification (U.S. + international)
• Income focus (bonds + dividends)
• Lower volatility (40% bonds)

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Balanced Global Portfolio (Age 35-50)

• 50% VTI (U.S. stocks) = $50,000
• 25% VEA (Developed markets) = $25,000
• 5% VWO (Emerging markets) = $5,000

• 15% BND (U.S. bonds) = $15,000
• 5% BNDX (International bonds) = $5,000

• 30% international stocks (global exposure)
• Moderate bond allocation (risk management)
• Balanced growth + stability

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Aggressive Global Portfolio (Age 20-35)

• 55% VTI (U.S. stocks) = $55,000
• 30% VEA (Developed markets) = $30,000
• 15% VWO (Emerging markets) = $15,000

• None (100% stocks for maximum growth)

• 45% international (maximum global diversification)
• Higher emerging markets allocation (growth potential)
• No bonds (all-in on equities)

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One-Fund Global Portfolio (Any Age)

• 100% VT (Vanguard Total World Stock) = $100,000

• 60% U.S., 40% international (market-weight)
• 9,000+ stocks globally
• Ultimate simplicity
• Auto-rebalances

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Using Money Monty to Find International Opportunities

Hey Money Monty, I want to add individual international stocks to my portfolio.

Can you suggest 5-7 of the best international stocks across:
- Europe (developed markets)
- Asia (Japan, South Korea, Taiwan)
- Emerging markets (China, India, Brazil)

Criteria:
- Market leaders in their industries
- Strong fundamentals (profitable, growing)
- Reasonable valuations
- Available as ADRs on U.S. exchanges

Give me a diversified list with brief explanations.

Hey Money Monty, compare these international ETFs for me:

- VEA (Vanguard Developed Markets)
- VXUS (Vanguard Total International)
- VWO (Vanguard Emerging Markets)

For each:
1. Holdings (what countries/regions)
2. Expense ratio
3. Dividend yield
4. Historical returns (5-year, 10-year)
5. Pros and cons

Which is best for a beginner wanting international exposure?

Hey Money Monty, which international region looks most attractive right now?

Compare:
- Europe
- Japan
- China
- India
- Latin America

Based on:
1. Valuation (P/E ratios vs. historical)
2. Economic growth outlook
3. Currency trends
4. Political/regulatory risks

Where should I be overweight or underweight?

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Success Checklist

• Understood why international diversification matters (40% of global markets)
• Learned the difference between developed and emerging markets
• Determined your target international allocation (20-40%)
• Chosen between developed vs. emerging split (typically 75/25)
• Selected implementation method (broad ETF, separate funds, or stocks)
• Understood currency risk and decided on hedging (unhedged recommended)
• Added international exposure to your portfolio
• Set up rebalancing plan (maintain target international %)
• Learned about foreign tax credits (claim on tax return)
• Used Sage to determine optimal allocation for your situation

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What’s Next?

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Related Workflows:

• Build Diversified Portfolio - Overall portfolio construction
• Sector Allocation Strategy - Diversify within U.S. stocks
• Rebalancing Your Portfolio - Maintain international allocation
• Monthly Portfolio Review - Track international performance
• Asset Location Optimization - Where to hold international stocks

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Continue Learning:

• Follow international market news (FT.com, Bloomberg, Reuters)
• Study economic trends in different regions
• Read Vanguard’s research on international diversification
• Join r/Bogleheads (strong international diversification advocates)

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Practice:

• Monitor international vs. U.S. performance monthly
• Review country/region weightings in your international ETFs
• Consider adding 1-2 individual international stocks you believe in
• Rebalance when U.S. or international drifts >5% from target