by Katerina Simons
November/December 1999

Interest in foreign investment has been high among U.S. investors in recent years. Many investors know that geographic diversification can improve investment returns without increasing risk. However, whether or not to invest abroad and, if so, how much weight to give to foreign investment, are questions often subject to heated debate. Whether or not to invest abroad is part of the larger question of how to assemble a portfolio that is appropriate for the investor's circumstances and degree of risk tolerance.

This article examines the question of international investing within the broader context of using portfolio optimization by individual investors. The author illustrates the concept by constructing portfolios from index funds based on major asset classes, including two foreign indices, European and Pacific, in addition to domestic stocks, bonds, and Treasury bills. She uses different measures of historical returns on these assets to construct optimal portfolios for various levels of risk; she finds that the results of portfolio optimization are highly sensitive to input parameters and, thus, to the way historical returns are measured.

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