International Market Access in Practice: Worked Example and Portfolio Context

Concepts for international investing become more useful when applied to a concrete portfolio decision. This article works through a specific example: building a simple globally diversified portfolio, comparing how it performed against a US-only alternative over a 20-year period, and explaining the practical mechanics of handling foreign taxes paid. The goal is not to prescribe an allocation but to demonstrate how the principles from the earlier articles in this series translate to actual portfolio construction and maintenance decisions.

A Simple Globally Diversified Portfolio

The three-fund portfolio is one of the most widely recommended structures in passive investing. Its international variant uses three ETFs or mutual funds to cover the entire global investable market at minimal cost: VTI (Vanguard Total Stock Market ETF) for US equity, VXUS (Vanguard Total International Stock ETF) for non-US equity, and BND (Vanguard Total Bond Market ETF) for US investment-grade fixed income. Together, VTI and VXUS cover virtually all publicly traded equities worldwide with market capitalization above a minimum size threshold.

A starting allocation for a long-term investor with 20-plus years to retirement might be 60% VTI / 30% VXUS / 10% BND. The 60/30 split within equities gives roughly a one-third international allocation of total equity, consistent with the guideline of 20% to 40% international exposure recommended for US investors by many portfolio researchers. The 10% bond allocation provides some dampening of equity volatility without substantially reducing long-term return potential at a long time horizon.

The all-in cost of this three-fund portfolio is approximately:

• VTI: 0.03% expense ratio
• VXUS: 0.07% expense ratio
• BND: 0.03% expense ratio

The blended expense ratio at a 60/30/10 allocation is 0.03% multiplied by 0.60, plus 0.07% multiplied by 0.30, plus 0.03% multiplied by 0.10, which equals approximately 0.018% plus 0.021% plus 0.003%, totaling about 0.042% per year. At $100,000 in assets, the total fund cost is approximately $42 per year. For a comparison, the average actively managed domestic equity mutual fund charges around 0.66% per year (Investment Company Institute data), or roughly $660 per year on the same assets.

Comparing US-Only vs. Globally Diversified Allocation: 2004 to 2023

The 20-year period from January 2004 through December 2023 illustrates both the cyclical nature of international relative performance and the argument for maintaining a global allocation through underperformance periods. This analysis uses MSCI World ex-USA Index data for international developed equities, MSCI Emerging Markets Index data for EM equities, and Russell 3000 Index data for US equities as proxies, since VXUS launched in January 2011.

The 2004 to 2007 period was dominated by international outperformance. International developed markets (MSCI EAFE) returned roughly 130% cumulatively from 2003 to 2007 while the Russell 3000 returned approximately 70%. Emerging markets returned even more. A US investor who held EAFE exposure in addition to domestic equities during this period significantly outperformed a US-only investor. The weak US dollar during this period amplified returns: foreign stocks rose in local currency terms, and those currencies appreciated against the dollar, adding another layer of positive return.

The 2008 to 2009 global financial crisis hurt nearly every market simultaneously, demonstrating that international diversification does not protect against systemic global downturns. The MSCI EAFE Index fell approximately 43% in 2008 in US dollar terms, slightly worse than the US market's 37% decline. Emerging markets fell approximately 53% in 2008. No international allocation provided meaningful protection during the acute crisis phase.

The 2010 to 2019 period was a decade of US dominance. The Russell 3000 returned approximately 256% cumulatively, while MSCI EAFE returned approximately 81% and MSCI Emerging Markets returned approximately 34% over the same period. US dollar strengthening during this period penalized international returns for US investors, adding to the equity underperformance. Many investors who had maintained international allocations through the decade saw those positions drag on their total portfolio returns for 10 consecutive years.

The 2020 to 2023 period showed neither extreme but included periods of international outperformance (particularly in 2022, when MSCI EAFE declined less than the S&P 500 in a down year for equities globally). As of late 2023, international equities continued to trade at significantly lower valuation multiples than US equities on metrics like price-to-earnings and price-to-book, which many value-oriented investors interpret as implying higher expected forward returns from international markets relative to US markets.

The key lesson from this 20-year history is not that international allocation always helps or always hurts, but that the relative performance cycles are long (often a decade or more) and unpredictable in timing. Investors who abandoned international exposure after the 2010-2019 underperformance missed the diversification benefit in 2022. Investors who abandoned international exposure after 2007-2008 missed the comparison context that would have made the 2004-2007 outperformance interpretable. Maintaining the allocation and rebalancing periodically captures the long-term diversification benefit without requiring a prediction of which market will lead next.

How Rebalancing Works in Practice

Rebalancing means periodically returning the portfolio to its target weights by selling positions that have grown beyond their target and buying positions that have fallen below it. For the 60/30/10 portfolio, if US equities outperform international over a period and the allocation drifts to 70% VTI / 25% VXUS / 5% BND, rebalancing requires selling some VTI and buying VXUS and BND to return to target weights.

Rebalancing triggers depend on investor preference. Two common approaches are calendar rebalancing (rebalance at a fixed interval, such as annually or semi-annually regardless of drift) and threshold rebalancing (rebalance when any holding drifts more than 5 percentage points from its target). Threshold rebalancing tends to be more tax-efficient in taxable accounts because it does not generate unnecessary taxable events when the portfolio hasn't drifted far from target.

In taxable accounts, rebalancing by selling appreciated positions generates capital gains. One way to reduce this tax friction is to direct new contributions to the underweight asset class rather than selling the overweight one. For an investor who adds $500 monthly to the portfolio, directing the entire contribution to VXUS when it is underweight achieves partial rebalancing without any sales. This method becomes less effective as the portfolio grows relative to the contribution size, but it is a useful tool in the early accumulation phase.

Handling Foreign Taxes Paid on VXUS Dividends

VXUS distributes dividends quarterly from the dividends collected on its roughly 8,000 underlying holdings. Many of those underlying stocks are in countries that withhold tax before paying dividends to the fund. The fund passes these withholding taxes through to shareholders via Form 1099-DIV, specifically in Box 7 (Foreign Taxes Paid) and Box 8 (Foreign Country or US Possession).

In a taxable account, the foreign taxes paid by VXUS can be claimed as a credit on Form 1116 of the US tax return, reducing US federal income tax dollar-for-dollar. The mechanics: if VXUS distributes $1,000 in dividends and reports $150 in foreign taxes paid (a 15% average withholding rate), you owe US income tax on the $1,000 dividend (at ordinary income tax rates if held less than 61 days around the record date, or at qualified dividend rates for eligible foreign dividends) and can subtract $150 from your US tax bill via the credit. The net US tax is your applicable rate on $1,000 minus $150.

Note that "qualified foreign dividends" (eligible for the lower 15% or 20% long-term dividend rate for US taxpayers) require that the dividend come from a foreign corporation that is eligible for benefits under a US tax treaty and that the investor has held the underlying shares (or, for ETFs, the ETF shares) for more than 60 days during the 121-day period around the record date. VXUS's Form 1099-DIV indicates what portion of the dividend qualifies for the lower rate.

In an IRA or Roth IRA, foreign taxes paid on VXUS dividends are permanently lost. The IRA does not pay US income taxes, so there is no US tax liability against which to credit the foreign taxes. The $150 in the example above is simply gone. For a VXUS position yielding 3% in an IRA, the permanent foreign tax drag is approximately 0.45% per year (3% yield multiplied by 15% average withholding rate), which is approximately six times VXUS's expense ratio and significantly reduces the after-tax return compared to holding VXUS in a taxable account.

Portfolio Construction Considerations: Country and Region Weights

VXUS at full market-cap weight gives roughly the following country exposures as of 2024 (approximate, changes over time): Japan 15-17%, United Kingdom 8-9%, China 7-9%, Canada 7-8%, France 5-6%, India 4-5%, Germany 4-5%, Taiwan 4-5%, Australia 3-4%, South Korea 3-4%, Switzerland 4-5%, with the remaining roughly 30% spread across dozens of other countries. No single non-US country dominates the allocation.

Investors who want to adjust country weights beyond market-cap can do so by adding a satellite position alongside VXUS. Overweighting emerging markets (for higher expected return at higher risk) can be achieved by adding VWO alongside VXUS. Overweighting Japan (perhaps for its historically low correlation with US markets) can be done through EWJ. Underweighting China (for governance or geopolitical concerns) is harder to achieve with standard market-cap ETFs, since most broad international funds hold China at market weight. Some funds have emerged that explicitly exclude China or weight EM ex-China, which would allow a separate China allocation decision.

The GDP-weight argument for international allocation suggests that countries with GDP shares larger than their equity market cap share deserve a higher allocation. In this framework, emerging markets (which represent a larger share of world GDP than of world stock market cap) would receive a higher weight than their market cap suggests. A simplified GDP-weighted international allocation might use 50% VXUS, 30% VWO, and 20% VEA within the international equity sleeve (roughly doubling emerging-market weight relative to market cap). This is more complex to maintain and rebalance but represents a coherent alternative to pure market-cap weighting for investors who believe equity market cap understates EM's economic importance.

A Note on the Foreign Tax Credit for Small Portfolios

For investors with international ETF holdings in taxable accounts but simple tax situations, the foreign tax credit is straightforward to claim. TurboTax, H&R Block, and similar software products have built-in Form 1116 support and import the relevant figures directly from Form 1099-DIV. The investor needs to indicate that the income is "passive category" (which applies to most foreign dividends from equity funds) and confirm the country or region. For a single international ETF holding with a straightforward tax return, the process adds perhaps 10 to 15 minutes to tax preparation.

The credit becomes limited (and calculation more complex) when: foreign tax credits from multiple countries are involved, the investor also has other foreign income sources like foreign business income or foreign rental income, the foreign tax rate is substantially higher than the US rate (creating an excess credit), or the investor's overall income is near phase-out thresholds. In any of these cases, consulting a tax professional familiar with international investing is worthwhile. The foreign tax credit can be quite valuable at scale: an investor holding $500,000 in VXUS in a taxable account might see $2,250 or more in foreign taxes paid annually, a meaningful reduction in US tax liability.