There are many ways in which to match the returns on major stock
indexes. The last decade has witnessed the explosive growth of both ex-
change-traded funds (ETFs) and index mutual funds. Both investment
vehicles closely track their respective indexes, have low turnover, and
are very tax efficient. Investors in capitalization-weighted index funds
should insist on a total annual expense ratio under 0.20 percent.
- Invest at least one-third of your equity portfolio in international
stocks, currently defined as those not headquartered in the United
States. Stocks in high-growth countries often become overpriced and
yield poor returns for investors.
Today the United States has less than one-half of the world’s equity
capital, and that fraction is declining rapidly. Owning foreign stocks is a
must in today’s global economy. In the future, the geographic location of
the firm’s headquarters will lose its importance as an investment factor.
What, where, and to whom a firm sells its products will dominate a new
classification system.
As Chapter 10 explains, traditional risk-return analysis on historical
data indicates that more than one-third of dollar-based portfolios should
be invested in stocks headquartered outside the United States. Despite
the increase in the short-term correlation between country returns, the
case for international investing is persuasive. In all countries studied, the
return on stocks has handily beaten bonds and fixed-income assets over
the last century. Do not overweight high-growth countries, as the data
presented in Chapter 9 show that investors often overpay for growth. - Historically, value stocks—those with lower P-E ratios and higher div-
idend yields—have superior returns and lower risk than growth stocks.
Tilt your portfolio toward value by buying passive indexed portfolios of
value stocks or, more recently, fundamentally weighted index funds.
Chapter 9 demonstrated that stocks with low P-E ratios and high
dividend yields have outperformed the market over the past 50 years
and have done so with lower risk. One reason for this outperformance is
that prices of stocks are often influenced by factors not related to their
true value, such as liquidity and tax-motivated transactions, rumor-
based speculation, and buying and selling by momentum traders. In
these circumstances, stocks priced low relative to their fundamentals
will likely offer investors a better risk and return profile.
Investors can take advantage of temporary mispricings by buying
low-cost passively managed portfolios of value stocks or newly devel-
opedfundamentally weighted indexesthat weight each stock by its share of
362 PART 5 Building Wealth through Stocks