China is the world's second-largest economy based on gross domestic product (GDP), trailing only the U.S. Despite that, the Chinese economy has grown stagnant in its efforts to rebound post-COVID.
Every economy has many working parts, so it's hard to pin the issues on one specific problem, but many experts think it comes down to a lack of policies aimed at economic recovery.
Whatever the case, the lagging economy is reflected in Chinese stocks. Two of the country's most-followed indexes, the S&P China 500 and MSCI China, are down considerably in the past three years. It's the opposite of how the most important index in the U.S., the S&P 500, is doing.
Data by YCharts.
China's slump hasn't been good for investors, but it has pointed to a larger lesson about investing in international stocks.
The importance of investing in international companies
When it comes to investment wisdom, diversification is high on the list. For most investors, having a diversified stock portfolio is more of a necessity than a recommendation because it can reduce risk and increase your return potential.
Diversification among companies, industries, and growth prospects is often preached, but geographic diversification is just as important. You can rarely go wrong with investing in the U.S. economy over the long run, but you don't want your portfolio to be completely at the mercy of its performance.
You also don't want to shortchange yourself by ignoring the many investment and growth opportunities around the world. Some sectors and industries globally provide exposure to trends and investments that aren't available in the U.S.
Investors should want diverse international stocks
China's current stalling economy is a reminder about the importance of investing in both developed and emerging markets.
Developed markets are regions with advanced economies, sophisticated financial systems, political stability, and solid infrastructure. Emerging markets are regions rapidly developing toward accomplishing those goals but are not quite there yet. For perspective, here are where some countries fall on the list:
| Developed | Emerging |
|---|---|
| United States | China |
| United Kingdom | Brazil |
| Japan | India |
| Australia | Mexico |
| Canada | South Africa |
Source: MSCI Inc.
Investing in both market types gives investors access to the unique growth opportunities each presents while hedging the inherent risk that each has.
Emerging markets specifically are high risk, high reward. Since they're in growth mode, investors can capitalize on the high return potential with their expanding economies. But they are also at a higher risk of economic volatility, unpredictable regulatory environments, and lack of transparency -- as many would say about China currently.
A balanced approach within international stocks themselves can go a long way for investors.
One international ETF could be all an investor needs
Researching individual companies can already seem like pulling teeth for some investors. It can be worse when it's an international company because you must consider factors you wouldn't necessarily have with a U.S. company (including the local economy and politics, currency exchange rates, and the like).
The most efficient way to invest in international stocks as a whole is via a broad exchange-traded fund (ETF). The Vanguard Total International Stock ETF (VXUS -0.22%), for example, contains over 7,900 stocks from the following regions:
- Emerging markets: 25.4%
- Europe: 40.3%
- Pacific: 26.8%
- North America: 7.1%
- Middle East: 0.4%
Not only does VXUS contain companies from all over the world, but it also contains companies of all sizes. There are small-cap, mid-cap, and large-cap companies, again exposing investors to both growth potential and stability.
It isn't the only approach, but having around 20% of your stock portfolio in international stocks is generally recommended. Adjust it to fit your financial goals and risk tolerance, but that's a good starting point.
