Most Americans don't have enough foreign stocks in their portfolios, according to an authority on asset allocation. By Steven Goldberg, Contributing Columnist September 9, 2008 Buy foreign stocks, including emerging markets. That's the latest word from Ibbotson Associates, one of the leading authorities on how to allocate your investments. Institutional investors, such as insurance companies and mutual funds, rely on Ibbotson for allocation advice and historical data. The Chicago-based company, a subsidiary of Morningstar, manages roughly $60 billion. For truly long-term investors -- those with more than 15 years to go before retirement and an ability to withstand short-term losses -- Ibbotson recommends putting a healthy 35% of your stock money overseas. That's the case even though Ibbotson expects the dollar to continue strengthening against the euro and the British pound. If that happens, money invested in those currencies would translate into fewer greenbacks, hurting results for U.S. investors in foreign stocks, says Michele Gambera, the firm's chief economist. (On the other hand, a stronger dollar could improve profits for many foreign companies, making their products more competitive in the U.S. and making it harder for U.S. exporters to compete in foreign lands.) Ibbotson believes the greenback will weaken against most emerging-markets currencies, as well as against the Japanese yen. Over the past 12 months through September 8, U.S. stocks are ahead of foreign stocks. The most popular index of foreign stocks has lost 20% while the broad-based Russell 3000 index of U.S. stocks has fallen 10%. Foreign stocks outpaced U.S. stocks in each year from 2002 through 2007. Advertisement Ibbotson isn't especially bullish or bearish on foreign stocks right now, Gambera says, but the firm's long-term view is that most U.S. investors have far too little invested overseas. After all, U.S. stocks account for only about 40% of the world's stock-market value. Gambera says the U.S. faces bigger economic challenges than most Western European countries. The issues include Americans' low savings rate, the high federal budget deficit and the huge trade imbalance. "These problems have been around for a while, and they need to be solved," Gambera says. He's also concerned about the excessive debt in the U.S. financial sector, which has contributed to the current credit crunch. The housing crisis is another big problem. "The housing industry usually plays a big part in getting the economy back on a growth path after a recession, but we know that's not going to happen anytime soon," Gambera says. Not that the economies of other countries are any great shakes either. Indeed, growth is dissipating throughout most of the developed world, and even the economies of emerging markets are slowing as they suffer from falling commodity prices and slackening demand for their exports. Nevertheless, Gambera says, foreign stocks look relatively cheap compared with U.S. stocks based on such measures as price-earnings ratios and dividend yields. Advertisement Before 2008, emerging markets had been sizzling, beating developed foreign and U.S. stocks in each of the past seven years. Year-to-date through September 8, emerging-markets stocks are down a sickening 28%. Ibbotson recommends a "neutral" weighting in emerging-markets stocks -- 10% of your stock money or almost one-third of the total amount you invest in overseas bourses. "Emerging markets have the most long-term growth potential," Gambera says. But in Ibbotson's view, real estate investment trusts -- high-yielding investments that are often viewed as safe havens -- look dangerous. Their price-earnings ratios are nearly double those of Standard & Poor's 500-stock index, Gambera says. "The valuations make no sense." He adds: "Earnings are likely to deteriorate because occupancy rates in shopping malls and apartments will fall." Despite those views, Ibbotson still recommends putting 8% of your stock money in REITs. That compares with 10% under normal conditions. I, for one, wouldn't invest in REITs today. Advertisement Ibbotson is surprisingly upbeat on stocks of small companies. Noting that small caps, over the long term, have beaten stocks of larger companies, the firm recommends investing 20% of your stock money in the little guys. That's about double the percentage of small caps in such broad-based indexes as the Russell 3000, but it represents a normal weighting for Ibbotston. Ibbotson says small caps are neither particularly pricey nor cheap in today's market. Most of the other experts I talk with find small caps expensive and recommend only a small allocation to them given the anemic global economy. Ibbotson suggests investing 60% of your stock money in so-called value stocks -- stocks of beaten-down companies selling at low prices, such as banks and other financial stocks. But most pros I respect currently recommend putting extra money in growth stocks because the Steady Eddies of the world -- companies such as Google and Procter & Gamble -- are capable of generating decent earnings growth even in a weak economy. Want to invest with Ibbotson weightings? I'd recommend putting 13% of your money in Longleaf Partners Small-Cap (symbol LLSCX), 29% in value hunter Dodge & Cox Stock (DODGX) and 23% in Vanguard Primecap Core (VPCCX), a growth fund. As for foreign stocks, you could put 30% in Julius Baer International Equity II A (JETAX) and 5% in T. Rowe Price Emerging Markets (PRMSX). The Julius Baer fund also has some assets in emerging markets. Steven T. Goldberg (bio) is an investment adviser and freelance writer.