Diversity requires foreign investments

Q. It has been suggested that since the U.S. market is a smaller portion of the total world financial market -- and because the U.S. dollar is falling -- it would be better to increase our exposure to non-U.S. markets to as high as 50 percent. What are your thoughts? -- J.E., by e-mail

A. Having some amount of investment in international markets is a good idea -- one I've advocated for years. Unfortunately, it isn't as simple as saying, "Well, let's make sure we don't forget Portugal or New Zealand." As a practical matter, you already have a substantial overseas investment when you buy shares in a major domestic index such as the Standard & Poor's 500 index or the Russell 1000 index.

Why?

Virtually every major American company earns a significant portion of its revenue outside of the United States. McDonald's and Coca-Cola, two quintessential American companies, both enjoy substantial foreign earnings. Ditto Intel and Exxon. Current estimates are that about one-third of earnings for the S&P 500 come from overseas. As a result, many of these companies will be enjoying substantial currency benefits even as we worry about the declining dollar.

The shoe fits on the other foot, too. Honda is a quintessential Japanese company, but a major portion of its sales and profits come from the United States.

As a result, you're an international investor even if you own only American companies. And you're less an international investor than you think when you own foreign companies.

That said, most Americans can, and should, make a much larger commitment to foreign investments, including emerging market investments, than they currently have. If you visit www.hewittassociates.com and check its 401(k) index, for instance, you'll find that the average 401(k) participant has only 10 percent of plan assets in international equities. A better figure would be a range of 30 percent to 50 percent.

Q. I have a question about determining my retirement asset withdrawal rate. One article I found refers to a T. Rowe Price study that says the best result "came from taking out an initial 4 percent of the portfolio and adjusting the withdrawal amount for inflation (use 3 percent annually)." Does this mean that I could take out 4 percent the first year and 4 percent plus 3 percent of the 4 percent the second year? This might seem to be a small question, but small numbers compound rapidly over the years. I don't want to make a mistake since I am now 73 years old. -- L.L., Houston

A. Most of the portfolio survival studies assume that you want to maintain your purchasing power in retirement. As a consequence, your initial withdrawal would be 4 percent of your original account value. Your withdrawal in the following year would be the original dollar amount increased by 3 percent to compensate for an assumed inflation rate of 3 percent.

(You can read a good deal more about this issue in the "Spenders' Portfolio and Portfolio Survival" category on my Web site, www.scottburns.com.)

Research shows that initial withdrawal rates of 4 percent to 5 percent are likely to last as long as you do. More recent research using more diversified portfolios that include international investments, REITs and commodities indicates you can start with a withdrawal rate of 5 percent.

Correction:ŒIn my Thursday, Dec. 6 column ("What Can We Do About Government Debt?"), I wrote that Ron Paul was the Republican candidate for president who favored the Fair Tax. That was incorrect. Mike Huckabee is the Republican candidate who favors the Fair Tax. Candidate Ron Paul favors another great idea, abolishing the IRS.

© 2007, Universal Press Syndicate