Many investors are afraid to invest in foreign stocks. For some of us, growing up in America may have created an image of people from different countries with strange customs, unstable governments and inedible food. America is politically stable, a democratic society and has a legal system that generally ensures companies and people have to play by rules that give everyone a relatively equal chance to succeed.
Foreign countries vary widely. Some are very unstable. Some are dictatorships. Some have no legal system to speak of. Governments can come and go, often in the midst of a revolution with large numbers of people dying as one side seizes power from another.
In the last 50 years, there have been dramatic changes. In the last decade there have been major changes. We are now clearly part of the global community. Trying to find products manufactured in the USA in our shopping malls or major department stores can be a challenge.
If your mindset about foreign countries is still stuck in the distant past (10 or more years), you may need to rethink how you view our role in the world and the role played by other countries in our economy.
We are a very prosperous nation. We are also addicted to cheap foreign products. America has a historically low unemployment rate at present. But our trade deficit continues to be horrific. We buy billions more in foreign products each month and each year than we sell overseas.
To be blunt, the products are being manufactured and the money is being made in foreign markets. We are making companies in foreign countries rich and some of these companies are buying our debt by purchasing bonds, Treasury bills and other financial instruments.
There isn’t much any of us can do about this on an individual level. What you can control, and what you need to consider, is how this will affect your investment philosophy.
Consider this: The American stock market has been on a tear recently. Headlines are everywhere about a major stock market index hitting new highs almost every week in the past several months. That is good news for investors and shows strength in our economy. With unemployment at very low levels, and the tax cuts passed by President Bush creating a positive business environment and more capital for investment, our economy has been humming along for a few years now.
But take a closer look at the statistics behind the headlines. Specifically, look at the TSP stock funds.
Since the close of the markets on December 31, 2005, how would you answer this question: Would you have made more money in the TSP I Fund or in the TSP C fund?
For some readers, the screaming headlines about stock market highs would lead to a quick answer that the C fund is the place to be in 2006. Here is the reality of your investment returns in these two funds so far in 2006.
C fund return: 12.2%I fund return: 19.6%
To take a rough hypothetical example that may bring the point home, if you had $100,000 in the C fund at the beginning of this year, you would now have about $112,200. That is a very good return.
If you had the same $100,000 in the I fund at the beginning of the year, you would now have about $119,600.
In less than eight months, putting your money into the I fund instead of the C fund would have given you an extra $7600. That difference would have funded a luxury cruise to the Caribbean for you and your spouse and one of your adult kids when you retire.
Don’t read this article and immediately sell your C fund shares (or your G fund or any other fund) and put all of your money into the I fund. It is easy to tell what has happened in the past and how much money you would have had if you had invested differently. It is much more difficult, probably impossible, to tell you how you will do in the future with a specific investment.
But, at a minimum, you need to consider how much of your money is invested in the I fund–if you have any at all invested in this fund. Many foreign countries have low inflation, stable governments and rapidly expanding economies. Some of these countries are not run by governments we admire or want to emulate. Some of these countries are places most of us would not want to live in. But you may want to participate in the ability of the companies in these countries to make money.
There are risks in putting your money in overseas stocks. There are also risks in putting your money into American stocks. Our population is older than in some other countries. We have a large economy that is not going to grow as fast as countries that have been lagging for decades (or centuries). Our economy is increasingly global and large amounts of money will be made in foreign countries. There are dicators and tyrants who can create problems and kill large numbers of people and create political instability with the push of a button and create instant chaos in politics and investments for years.
Not putting any of your investment funds in the I fund means you are eliminating the possibility of your retirement funds growing as a benefit of the profits being made in these foreign countries. If you think the American stock market is going to slow down and our economy will come to a standstill, you will want to invest more of your money in foreign markets.
If you think the American stock market is going to keep going up as it has in recent weeks and months, you will want to put more into the C fund and less into the I fund.
But the global economy means, for many, that you should consider diversifying your TSP funds to include some exposure to foreign stocks. If you are a number of years away from retirement, you can afford to take more risk and perhaps give yourself the possibility of larger gains over time with greater exposure to the I fund (and the S fund as well). If you are nearing retirement, you will probably want to minimize your risk with stock investments as you are likely to need the money sooner for your retirement expenses.
And, if the whole process gives you a headache and creates an inability to make investment decisions, you may want to consider the lifecycle funds and let the TSP bureaucracy make the decision for you by investing in the fund appropriate for your age and career status.