International Investing - How to really blow it!

Last Updated Aug 22, 2010 10:17 PM EDT

Last week, I received the following email from a reader who wasn't so happy with the Vanguard Emerging Market Index Fund ETF (VWO). He wrote:
I purchased VWO ETF assuming I was investing in Brazil, Russia, India and China. I don't know why it is performing so bad and it's in a Roth where I can't declare the loss.....
I paid so much more than the price today. I checked the top 10 holdings and I saw investments only in China. Would you know why this ETF has ended up to be a loser? This being an ETF, I would never get what I paid. I believe the fee is also too much? I purchased some at $78.00 and again at $96.00. I will never buy an ETF again.
Lesson 1: Don't performance chase
The VWO fund is Vanguard's largest ETF, much like iShares Emerging Market (EEM) is iShares largest ETF. Its popularity can be chalked up to the human nature of chasing what's hot, and emerging markets have been hot. As always, my advice is not to buy what's hot.

Lesson 2: Diversify
Emerging markets represent only 26% percent of the international stock market. The fact that emerging market ETFs are larger than broader international ETFs proves our unwillingness to diversify.

Lesson 3: Confusing a country's growth with their stock market growth
Jason Zweig once wrote a brilliant column in The Wall Street Journal showing that the countries with the fastest growing economies don't translate to the fastest growing stock markets. Much like growth vs. value stocks, high expectations are already built in to stock prices of countries like China, India, and Brazil.

Lesson 4: Do your research
While I happen to think it's a good thing that VWO and EEM aren't all in the hot countries, or have their top ten holding all being companies headquartered in China, it's important to research before you buy. Morningstar shows the country breakdown and that five of the ten largest holdings are in China.

Lesson 5: Asset location is key
The investor notes that he can't take a loss because he bought this ETF within his Roth account. Never forget that asset location is a critical part of investing. Equity ETFs generally belong in your taxable account.

To sum it up
Nothing in this email made any sense from the viewpoint of an investor, and that's because this email was clearly from a speculator. Even his claim that he bought VWO for $78 and $96 a share is peculiar given I don't show it ever reached $60. Yet, this person is not alone in making the five mistakes above.

My advice
As human beings, we are wired to make some or all of the same mistakes this reader made. When it comes to investing, however, we must rewire our instincts to resist those irrational emotional drivers. Pay close attention to the five investment lessons above. I can assure you that I've violated every one multiple times.

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    Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to over $50 million. The author of How a Second Grader Beats Wall Street, Roth teaches investments and behavioral finance at the University of Denver and is a frequent speaker. He is required by law to note that his columns are not meant as specific investment advice, since any advice of that sort would need to take into account such things as each reader's willingness and need to take risk. His columns will specifically avoid the foolishness of predicting the next hot stock or what the stock market will do next month.

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