03/11/2014 07:16 pm ET Updated May 11, 2014

The Secret to Dealing With Market Volatility

A review of what passes for financial news provides sobering insight into why so many investors historically earn subpar returns.

Jim Cramer provides more of his "top stock picks." Many wrongly assume he has some special insight that permits him to identify mispriced stocks, despite compelling evidence to the contrary. According to The Motley Fool, Cramer made correct predictions only 45.08 percent of the time, which is less than what you would expect from random chance. Another study (reported here) looked at 6,400 forecasts from 68 "experts" from 2005 through 2012. It gave Cramer an accuracy rating of 46.8 percent.

Another article speculated about an "upside" for gold miners. Yet another article predicted the S&P 500 sectors that "are likely to fare best in the next 12 months."

In sharp contrast to these emperors with no clothes, from those who pretend to have a predictive expertise that does not exist, there is sound data that is of real value to investors. This data provides support for the view that the secret to lower volatility is upping your allocation to international stocks.

According to research from Vanguard, over the past several decades, investors who had exposure to both international and domestic stocks earned similar returns but with lower average volatility. This is because international stocks don't correlate perfectly with the U.S. stock market.

Vanguard recommends a "reasonable starting allocation" of 20 percent to international stocks. However, you can make the case for a significantly higher allocation. Vanguard notes that U.S. stocks made up only approximately 46 percent of the global market, as of the end of 2011. If you believe (as I do) that markets are reasonably efficient and prices almost instantaneously incorporate all publicly available information, it would be entirely consistent with sound financial theory to allocate the balance of 54 percent to international stocks.

My colleague Larry Swedroe notes another benefit of increased exposure to international stocks. He observes that "the higher your allocation to international stocks, the lower your overall equity allocation can be."

An easy, low-cost way to access international stocks is through an index fund, like Vanguard's Total International Stock Index Fund (VGTSX). It has a very low management fee of 0.22 percent.

The next time your broker wants to discuss picking mispriced stocks or selecting the next "hot" mutual fund, switch the focus to the amount your portfolio is allocated to international stocks.

Dan Solin is the director of investor advocacy for the BAM ALLIANCE and a wealth advisor with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. His next book, The Smartest Sales Book You'll Ever Read, will be published March 3, 2014.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

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