Want to give your portfolio an edge? Try investing globally

There are nearly 70 stock markets offering their wares to investors around the globe.  Sexy, up-and-coming markets like China beckon, while exotic markets like Turkey’s and Russia’s are growing fast. How should an investor allocate his limited investment dollar?  Probably the best method involves following the actual capitalization of the world’s markets, that is, investing the most in the biggest markets and the least in the smallest.  Market capitalization is simply the total value of all shares in a market multiplied by their prices.

By that measure, the U.S. stock market still dominates the world, with an estimated $15.7 trillion, or 41 percent of the world’s stock market value at the end of 2007. A few years ago the United States accounted for more than half of the world’s stock market value.  Although the total dollar value of U.S. stocks has grown in recent years, other markets have grown even faster.  That means your portfolio should still have a home market bias and that you shouldn’t go wild throwing all of your money at foreign markets. It is hard enough to follow the global market capitalization and invest more than half of your money outside the U.S.

Roger Gibson, a money manager and author of a textbook on investment diversification, notes that U.S. investors define their success by keeping up with, or beating, U.S. market averages. “Investors compare their investment results with their friends? results while playing golf or at cocktail parties,” he writes. In a year when the U.S. market beats most foreign markets, the investor with more foreign holdings will do worse than his neighbor who invests only in domestic stocks. “There is pain in being different,” Gibson warns. Investors who understand this phenomenon and can live with short-term disappointment have a better chance of beating the U.S. stock market in the long run.

So where should your international money go – to rocketing markets like China or India?  The answer is yes, but in proportion: Despite terrific growth in those two economies in recent years, together they make up just 3 percent of the global market capitalization.  Great Britain has the world’s largest stock market after the United States, at 9 percent of the total, closely followed by Japan, also at about 9 percent. Europe follows as the next biggest market: 15 major European markets account for another 20 percent of the global stock market. Including Japan’s 9 percent, Asian markets account for only about 20 percent of market capitalization and that includes a 3 percent share for Australia. This means a U.S. investor using a European stock mutual fund and an Asian stock fund to round out his portfolio might want to invest a little more in Europe than in Asia.

One trend U.S. investors should note is the growth of stock markets in emerging economies. The stocks of all emerging markets – including countries like Brazil, Mexico, China, and South Korea – now make up a little more than 10 percent of the world’s market capitalization. An investor who ignores those markets might be giving up on the potential for major future growth.