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How international small-caps spice up a retirement portfolio

Reprinted courtesy of MarketWatch.com.

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Savvy investors have known for many years that small-cap stocks provide a good vehicle for boosting long-term performance. This has been even more true for international companies as it has been for U.S. ones.

Let’s see if the numbers back up that claim. (Hint: they do.)

In the 45 calendar years from 1970 through 2014, U.S. small-cap blend stockscompounded at 13%, compared with 10.5% for the Standard & Poor’s 500 IndexSPX, +0.47%  , also a blend of value and growth.

While that’s impressive, in those same years, international small-cap blend stocks compounded at 14.6%.

These numbers are easier to comprehend if you calculate the growth of a hypothetical $100 initial investment in 1970. At the end of last year, that $100 would have been worth $8,845 invested in the S&P 500, or $24,486 in U.S. small-cap blend stocks, or $45,387 in international small-cap blend stocks.

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In other words, investors in international small-cap blend stocks achieved more than five times the benefit, compared with investors in the S&P 500.

Even though the future will inevitably be different, these 45 years may provide a reasonably valid comparison among these asset classes. This 45-year period includes three major bear markets, three strong recoveries and a long period of economic expansion, especially in the U.S. stock market.

I’m not suggesting that international small-cap blend stocks are an alternative to either the S&P 500 or to U.S. small-cap blend stocks. While I recommend including equal parts of all these equity asset classes (along with equal parts of seven more), I want you to look for a moment at international small-cap blend stocks as a single way to diversify beyond the S&P 500 Index.

If in 1970 you invested that $100, dividing it equally between the S&P 500 and international small-cap blend stocks and rebalancing once a year, by the end of 2014 your compound return would have been 12.9% (versus 10.5% for the S&P) and your $100 would have grown to $23,508 (versus only $8,845 for the S&P 500 alone).

If those numbers don’t convince you of the long-term value of international small-cap blend stocks, I don’t know what it would take.

Most investors don’t sock their money away for 45 years at a time, of course. So I looked at 15-year periods (there were 33 of them) and found that international small-cap blend stocks were a great addition to the S&P 500.

On average, the 15-year compound returns were 14.8% for international small-cap blend stocks, versus 11.8% for the S&P, and 13.6% for a combination of these two asset classes, with annual rebalancing.

The risk of this combination, I should add, was lower (measured by standard deviation) than that of either U.S. or international small-cap blend stocks by themselves.

The evidence is clear: International small-cap blend stocks have been an excellent way to diversify beyond the S&P 500 Index.

Next up: international small-cap value stocks, an asset class with a similarly impressive track record since 1982.

Note to readers: I will be speaking on May 7 in Portland, Ore. for the American Association of Individual Investors. The presentation lasts three hours.

Richard Buck contributed to this article.