Is This Global ETF the Most Effective Way to Diversify in Today's Market?

U.S. retail investors allocate less than a quarter of their portfolios to overseas stocks, according to John Hancock and Cerulli Associates. That's probably because Americans are more familiar with domestic companies than overseas ones, and they believe the U.S. equity market -- as reflected in the S&P 500's long-term gains -- will keep growing.

But with the S&P 500 trading at a historically high 30 times earnings, it might be the right time to boost your exposure to overseas equities. Chaotic policy shifts, sticky inflation, and political instability could also make international stocks look more attractive than U.S. stocks.

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If you're wary of picking individual overseas stocks, it's a good idea to invest in an exchange-traded fund (ETF) that already holds the top international stocks. One of those top funds is the Vanguard Total International Stock ETF (NASDAQ: VXUS), the world's largest global ETF that excludes U.S. stocks. Let's see why it might be worth buying.

What does VXUS actually own?

The Vanguard Total International Stock ETF tracks the FTSE Global All Cap ex. US (excluding U.S.) index. It holds 8,669 stocks with a median market cap of $46.4 billion and an average earnings growth rate of 15.4% -- and it trades at just 17 times earnings, making it a lot cheaper than the S&P 500.

The ETF's top holdings include Taiwan Semiconductor Manufacturing (3.02% of the fund), Tencent (1.29%), ASML Holding (1.07%), Alibaba Group Holding (0.98%), and Samsung Electronics (0.91%). Unlike retail U.S. investors, who usually only have access to these companies' U.S.-listed American depositary shares or thinly traded over-the-counter (OTC) shares, VXUS directly buys the overseas shares. U.S. investors also usually can't directly invest in Samsung.

VXUS allocates 37.5% of its portfolio to Europe, 27.6% to emerging markets, 26% to the Pacific, 7.7% to North America, 0.7% to the Middle East, and the remaining sliver to other markets. Its top five countries are Japan (15.4% of the fund), China (9.1%), the U.K. (8.9%), Canada (7.7%), and Taiwan (6.3%). As of Oct. 13, it held $554.3 billion in total net assets.

The fund's quarterly dividends fluctuate wildly because it's invested in so many companies, but it still paid a decent 2.78% yield over the past 12 months. By comparison, the popular Vanguard S&P 500 ETF (NYSEMKT: VOO) -- which closely tracks the S&P 500 -- paid a trailing yield of only 1.15%.

Like VOO, VXUS is a passively managed fund that automatically tracks a benchmark index. That's why VXUS only charges a low expense ratio of 0.05%, which is higher than VOO's expense ratio of 0.03% but much lower than the average expense ratio of 0.85% for similar international funds.

Will VXUS outperform VOO over the next few years?

Over the past five years, VXUS generated a total return of 46% as VOO delivered a total return of 98%. VOO's rally was largely driven by the biggest tech companies in the U.S. -- Nvidia, Microsoft, Amazon, and Apple -- which benefited from the rapid growth of the cloud and AI markets.

Those stocks could keep rising over the next few years, but their cloud and AI tailwinds could dissipate. As their growth cools off, their valuations will decline and drag down the S&P 500. That decline could drive more investors back toward cheaper overseas stocks, while lower interest rates could weaken the U.S. dollar and generate even stronger tailwinds for VXUS's overseas holdings.

According to the base case of Vanguard's own Capital Markets Model (VCMM), overseas (excluding U.S.) equities could outperform U.S. stocks by 2.2% annually from 2023 to 2033. While the past five years were great for the S&P 500 and VOO, the next five years might belong to VXUS and other global ex-US ETFs.

So if you're looking for a simple, no-brainer way to diversify your portfolio away from the U.S., the Vanguard Total International Stock ETF checks all of the right boxes.

Leo Sun has positions in ASML, Amazon, and Apple. The Motley Fool has positions in and recommends ASML, Amazon, Apple, Microsoft, Nvidia, Taiwan Semiconductor Manufacturing, Tencent, Vanguard S&P 500 ETF, and Vanguard Total International Stock ETF. The Motley Fool recommends Alibaba Group and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.