Slice and dice international

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As an alternative to investing in a foreign total market fund, it is possible to slice and dice international allocations by holding separate regional funds: emerging markets plus either a developed markets fund or separate pacific rim and european funds.

Characteristics of slice and dice
The primary advantage of a total market fund is simplicity: a single fund whose market weights are maintained automatically. A secondary benefit for a Vanguard investor is the potential inclusion of Canadian stocks, which represent about 6% of Vanguard Total International Index Fund.

Possible advantages/disadvantages of slicing and dicing internationally revolve around costs, taxes, and diversification.

Expense ratio comparison
The relative cost advantage of using ETF or investor/admiral shares is dependent on many factors, including size and frequency of the investment, expected holding period, the level of commission and trading costs, and realized return. To determine the relative costs between an ETF/mutual fund decision, one can use the Vanguard Cost Comparison calculator.

Taxes

 * Foreign tax credit. With the transition of Vanguard Total International Stock Index Fund and Vanguard Developed Markets Index Fund from fund of funds to funds now directly holding stocks, all Vanguard international funds fully qualify for the foreign tax credit.


 * Tax loss harvesting. Slicing and dicing the international allocation may give rise to more tax loss harvesting opportunities because the components (Europe, pacific, and emerging markets) do not necessarily move in the same directions.


 * Qualified dividend. Qualified dividends, which are subject to a maximum 20% tax rate (15% for tax year 2012), were realized over the past five years at the percentage rates indicated in the following table. Only the tax-managed international approach appears likely to attain a sustainable realized qualified dividends advantage.

Diversification of currencies
According to Rick Ferri in All About Asset Allocation, having fixed allocations between Europe, pacific, and emerging market diversifies currencies better than one fund.

Possible rebalancing bonus
Also according to Rick Ferri, rebalancing of those currencies "could provide a diversification benefit, as it has in the past". William Bernstein suggests a rebalancing bonus may be obtainable with emerging markets (see External links below). Note that rebalancing in a taxable account may lead to payment of capital gains taxes.

Overweighting pacific or emerging markets
Historically Europe has been more correlated with the U.S. market than pacific and emerging markets, so the investor may want to overweight pacific or emerging markets. The current market weight as of 01/31/2010 is approximately 50.1% Europe, 26.2% pacific and 23.7% emerging market according to the allocation of Vanguard Total International Stock Index Funds, which follows the  market capitalization.

Avoiding regional bubbles
Total market funds will change as the underlying market weights change. With Japan as an example, maintaining a fixed weight to Japan/pacific in the 80's might have avoided an overallocation to Japan. More recently, in 2010 emerging markets increased to 23% of the world market from about 4% in 1998.