International Developed Markets Investing Explained: VXUS, EFA, and the Case for Global Diversification

May 9, 2026 · guides · 14 min read

International Developed Markets Investing Explained: VXUS, EFA, and the Case for Global Diversification

Ask a self-directed US investor how much of their portfolio is in international stocks, and you will often hear something between zero and ten percent. Ask them why, and you will frequently hear some version of: "US stocks have outperformed for a decade, and US companies are global anyway."

Both of those statements are true. Neither is a complete argument for ignoring international diversification. This guide covers what international developed markets are, why the historical case for owning them is stronger than recent performance suggests, how to access them efficiently, and how the tax treatment in different account types should influence your allocation.

What International Developed Markets Are

The phrase "international developed markets" refers to countries that have established market economies, deep capital markets, and regulatory frameworks broadly comparable to the United States. They are distinguished from "emerging markets" -- which include countries like China, India, Brazil, South Korea, and others with rapidly growing but still-developing financial infrastructure -- and from "frontier markets," which are the smallest and least liquid.

The benchmark index for developed markets outside North America is the MSCI EAFE (Europe, Australasia, and Far East). EAFE has been around since 1969 and is one of the oldest international equity benchmarks in existence. It covers approximately 21 countries, with the largest weights typically held by Japan, the United Kingdom, France, Germany, Switzerland, and Australia.

A key detail: EAFE excludes Canada. Canadians joke about this regularly. The MSCI All Country World ex-US (ACWI ex-US) and the Vanguard Total International Stock ETF (VXUS) include Canada. When you see a US investor comparing "US vs. international," they are often comparing against EAFE specifically -- so Canada, which behaves somewhat differently from European markets due to its heavy natural resource and financial sector weighting, is sometimes missing from the comparison.

Country Weights in EAFE (Approximate, as of recent years)

These weights shift as relative market capitalizations change. Japan's weight has compressed significantly from its peak of over 40% in the late 1980s during the Tokyo bubble. The UK's weight has been compressed by the relative decline of FTSE 100 constituents.

The US Home Bias Problem

Behavioral finance researchers have documented a pervasive phenomenon called home bias: investors systematically overweight domestic equities relative to what global market cap weights would suggest.

US investors are among the most home-biased in the world. The United States represents approximately 60-65% of total global equity market capitalization, depending on the year and how you measure it. Yet survey data and aggregate fund flow data consistently show that US retail investors hold 70-85% of their equity portfolios in domestic stocks, leaving 15-30% for the entire rest of the world.

This matters because most investors do not perceive home bias as a risk. They perceive it as the default, the normal state, the sensible position given that they live and spend in US dollars. But from a risk management perspective, concentrating 70-80% of a portfolio in a single country -- even the world's largest economy -- is a meaningful undiversification.

Consider what home bias would have meant for a Japanese investor in 1989. The Nikkei 225 peaked at approximately 38,957 on December 29, 1989. It did not recover to that level for more than 34 years. A Japanese retail investor with 80% domestic equity exposure and 20% international exposure would have experienced dramatically different outcomes than one with 50% domestic and 50% international.

The US has not experienced anything remotely comparable to Japan's lost decades, and there are many structural reasons to believe it is unlikely to. But the principled case against undiversified country concentration does not depend on believing a catastrophic scenario is likely. It depends on recognizing that concentrating in a single country -- even the best-performing country over the past century -- creates exposure to risks that an investor is not compensated for bearing.

The Valuation Argument for International

One of the most persistent data points in favor of international developed markets is the valuation gap relative to US equities.

As of recent years, the MSCI EAFE has traded at approximately 13-15x forward earnings, compared to 20-22x for the S&P 500. This represents a discount of roughly 30-40% on a forward P/E basis.

Valuation gaps of this magnitude between developed markets have historically not been permanent. They compress -- either by international markets re-rating upward, US markets de-rating, or some combination. The question is whether the current gap is explained by structural differences that justify a permanent discount, or whether it represents an opportunity.

The structural argument for why international should trade at a permanent discount includes:

The counter-argument is that much of this is already priced into those higher multiples. A forward P/E of 22x for the S&P 500 implies that investors expect higher earnings growth from US companies -- and they may be right, but the premium for that expected growth is already in the price.

Historical research by Elroy Dimson, Paul Marsh, and Mike Staunton (authors of the Credit Suisse Global Investment Returns Yearbook) shows that over very long periods, equity returns across developed markets have been more similar than short-term performance suggests. The US has been the best-performing single market over the 20th and early 21st centuries, but its outperformance relative to other developed markets has been less dramatic than commonly believed when survivorship bias and other methodological issues are controlled for.

The Robert Shiller CAPE ratio applied internationally also supports the valuation case for non-US markets. As of recent data, CAPE ratios for Japan, the UK, France, and Germany have all been substantially below the US CAPE, which has been elevated by historical standards. Academic research by Meb Faber, among others, has shown that CAPE-based country tilting -- overweighting cheaper markets -- has historically added value over the subsequent 5-10 year horizon.

The "US Decade" Problem

From roughly 2010 through 2020, US equities dramatically outperformed international equities. The S&P 500 returned approximately 13.6% annualized over that decade. The MSCI EAFE returned approximately 5.7% annualized over the same period in US dollar terms. The gap was enormous, and it persisted for long enough that many investors concluded international diversification was simply a bad idea.

This conclusion represents exactly the kind of recency bias that long-term investors should guard against.

The prior decade tells the opposite story. From 2000 to 2009, the MSCI EAFE outperformed the S&P 500 significantly. The S&P 500 returned approximately -0.9% annualized from 2000 to 2009 -- the "lost decade" for US equities -- while EAFE returned approximately 1.2% annualized in dollar terms. Investors who had abandoned international exposure after the outperformance of US equities in the late 1990s paid a significant cost.

The cycle between US and international outperformance has been documented extensively. It is long -- often a decade or more -- which is precisely why investors tend to extrapolate it rather than anticipate its end. But from a structural perspective, the conditions that drive the cycle are well understood:

All three of these factors have at various points supported the case for international outperformance being more likely than the recent decade suggests.

Currency Risk: Hedged vs. Unhedged Exposure

When a US investor buys shares in a Japanese company, they get two sources of return: the return of the underlying stock, and the return (or loss) from the movement of the yen against the dollar. If the stock goes up 10% in yen terms but the yen weakens 8% against the dollar, the US investor gets only about 2% in dollar terms.

Currency exposure adds both risk and return to international positions. Investors can choose to eliminate it using currency-hedged ETFs.

The three main options for EAFE exposure illustrate the range of choices:

EFA (iShares MSCI EAFE ETF, expense ratio 0.32%) holds unhedged positions in EAFE stocks. Investors get full currency exposure. When international currencies strengthen against the dollar, EFA returns are enhanced. When the dollar strengthens, EFA returns are diminished.

HEFA (iShares MSCI EAFE Hedged Equity ETF, expense ratio 0.35%) attempts to eliminate currency risk by using forward contracts to hedge the currency exposure back to US dollars. The investor gets the underlying equity return with minimal currency return.

SPDW (SPDR Portfolio Developed World ex-US ETF, expense ratio 0.04%) holds unhedged exposure, similar to EFA, but with a dramatically lower expense ratio. SPDW tracks the S&P Developed ex-US BMI index rather than MSCI EAFE, which leads to minor methodology differences.

The academic evidence on whether to hedge international currency exposure is nuanced but leans toward a practical conclusion: over investment horizons of 10 years or more, currency hedging adds minimal value in expectation. Short-term currency movements are volatile but mean-reverting over longer periods. The cost of hedging -- the carry cost embedded in the forward contracts -- tends to roughly offset the volatility reduction benefit over long horizons.

Vanguard's research on currency hedging in international equity allocations found that unhedged exposure is generally appropriate for long-term equity investors, while hedged exposure may be more appropriate for shorter holding periods or international bond allocations (where currency volatility is large relative to expected bond returns).

The practical exception: if you expect a sustained dollar strengthening trend -- for instance, if US interest rates remain significantly higher than international rates for an extended period -- hedged exposure will outperform. But reliably forecasting multi-year currency trends is extremely difficult, and many currency forecasters have long records of failure.

Sector Composition: Why EAFE and S&P 500 Are Different Animals

A common dismissal of international diversification is that large US companies are already global -- Apple sells iPhones in Japan, McDonald's operates in France, and so forth. Therefore, owning US multinationals already provides international exposure.

This argument has some merit for revenue exposure but misses the sector composition story entirely.

The MSCI EAFE index has a dramatically different sector composition than the S&P 500:

S&P 500 sector weights (approximate, recent years):

MSCI EAFE sector weights (approximate, recent years):

The structural underweight in technology and overweight in financials, industrials, and consumer staples is the most important characteristic of EAFE from a factor perspective. Technology companies tend to have high growth rates, high margins, asset-light business models, and high valuation multiples. The EAFE composition tilts toward slower-growing, more capital-intensive businesses with lower multiples.

This means EAFE tends to outperform the S&P 500 in environments that favor value and cyclical stocks over growth stocks, and underperforms in environments where technology leadership is rewarded. The 2010s were a technology-leadership decade in US markets; EAFE underperformed. The 2000s saw value and international outperformance after the US technology bubble deflated.

Understanding this sector composition difference is essential to forming realistic expectations about when international exposure will and will not add value to a US-dominated portfolio.

The Main ETF Options: EFA, VXUS, SPDW

For US-based investors seeking international developed market exposure, three ETFs dominate in terms of liquidity and assets under management.

VXUS -- Vanguard Total International Stock ETF

Expense ratio: 0.07% Assets under management: among the largest international ETFs

VXUS tracks the FTSE Global All Cap ex-US Index, which is the most comprehensive of the major international benchmarks. It includes approximately 8,000+ stocks across both developed and emerging markets outside the United States. This means VXUS blends developed market and emerging market exposure in a single fund.

Critically, VXUS includes Canada, which EAFE does not. It also includes a meaningful emerging markets weight -- roughly 25-30% of the fund is in emerging markets (primarily China, India, Taiwan, South Korea, Brazil, and others). Investors who want pure developed market exposure without emerging markets should note this.

VXUS is the most diversified international option available and has the cost advantage of Vanguard's structure. For investors who want one fund for all international exposure, VXUS is the natural choice.

EFA -- iShares MSCI EAFE ETF

Expense ratio: 0.32% Assets under management: very large; one of the oldest international ETFs

EFA tracks the MSCI EAFE index, which excludes Canada and excludes emerging markets. It provides pure developed market exposure outside North America, concentrated in Europe, Japan, Australia, and a handful of other developed economies.

At 0.32%, EFA is meaningfully more expensive than SPDW and significantly more expensive than VXUS. Its main advantages are its long track record (launched in 2001), its enormous liquidity, and the recognition of the MSCI EAFE benchmark it tracks. For institutional-minded investors who want to track the most commonly cited developed markets benchmark, EFA is the reference ETF.

SPDW -- SPDR Portfolio Developed World ex-US ETF

Expense ratio: 0.04% Assets under management: growing rapidly, smaller than EFA

SPDW is effectively a low-cost alternative to EFA. It tracks the S&P Developed ex-US BMI index, which covers developed markets outside the US (including Canada, unlike EAFE). At 0.04%, its expense ratio is one of the lowest available for any international equity ETF.

The methodology difference -- SPDW includes Canada, EFA does not -- matters modestly. Canada represents roughly 8-10% of total developed world ex-US market cap. Canadian equities are heavily weighted toward energy, financials, and materials. Including Canada adds some commodity cycle sensitivity that EAFE does not have.

For cost-conscious investors who want pure developed market exposure at minimal cost, SPDW is currently the most efficient option available.

The Foreign Tax Credit: A Tax Advantage Often Overlooked

Dividends paid by international companies are subject to foreign withholding taxes. Most developed market countries withhold 15% on dividends paid to US investors, though rates vary. Switzerland withholds 35%, Japan withholds 15.315%, and France withholds 12.8% for US investors under treaty rates.

When you own an international ETF in a taxable account, the fund pays these taxes on your behalf. The taxes show up on your Form 1099-DIV as "foreign taxes paid." US tax law allows you to claim a foreign tax credit for these amounts, effectively getting the withheld tax back as a credit against your US tax liability.

For most retail investors, the foreign tax credit roughly offsets the foreign withholding tax, making international ETFs in taxable accounts approximately tax-neutral on the dividend income -- you pay a tax to a foreign government but get a credit against your US taxes for the same amount.

Here is the crucial point that many investors miss: this foreign tax credit is not available for international ETFs held in IRAs or 401(k)s. Because IRA distributions are not subject to US tax (Roth) or are taxed as ordinary income at withdrawal (Traditional), there is no US tax liability against which to apply the foreign tax credit. The foreign withholding taxes paid on dividends within an IRA are simply lost -- you pay the foreign tax with no credit to offset it.

This creates a meaningful tax preference for holding international equity ETFs in taxable accounts rather than IRAs or 401(k)s, opposite to the typical conventional wisdom that favors putting equities in tax-deferred accounts.

The effect is not enormous -- international ETF dividend yields are typically 2-3%, and 15% withholding on a 2.5% yield represents 37.5 basis points of return lost annually in a tax-deferred account -- but across decades and large account balances, it compounds meaningfully.

Japan: The Largest Single-Country Story in EAFE

Japan deserves special attention because it is the largest single-country allocation in EAFE at approximately 20-24% of the index, because its economic story is so distinctive, and because developments in Japan over the past several years have significant implications for global investors.

Japan spent roughly three decades -- from the early 1990s to the mid-2010s -- in a deflationary or near-deflationary environment following the collapse of its asset price bubble. Corporate Japan was notorious for hoarding cash, cross-holding shares in other companies (a practice called keiretsu), and running businesses for stability rather than shareholder return. Return on equity for Japanese companies was structurally lower than for comparable US or European companies.

The Nikkei 225 did not recover its 1989 peak until 2024. The intervening 34 years involved multiple lost decades for domestic Japanese equity investors.

Beginning around 2012 with the Abe administration's "Abenomics" program and accelerating in recent years under the Tokyo Stock Exchange's corporate governance reform campaign (which publicly named companies trading below book value and encouraged them to either create value or face delisting pressure), Japanese corporate behavior has been changing. Buybacks have increased. Dividends have grown. Cross-shareholding has been unwound. ROE has improved.

The Bank of Japan's yield curve control (YCC) experiment is a separate and significant development. From 2016 until its gradual unwinding beginning in 2024, the BoJ maintained a policy of targeting the 10-year Japanese government bond yield at or near zero, buying unlimited bonds as necessary to defend the cap. This had significant implications for global bond markets, the yen, and Japanese financial stocks.

As the BoJ has begun normalizing policy -- allowing yields to rise and eventually abandoning YCC -- Japanese financial institutions (banks, insurance companies, and brokerages) that had been squeezed by near-zero rates are now facing better profitability prospects. This is a structural tailwind for a segment that represents a meaningful share of the EAFE index.

For investors in EAFE-tracking ETFs, Japan's corporate governance reform is one of the more interesting structural developments in international developed markets today, and it provides a data-specific example of why EAFE cannot be dismissed as a monolithic slow-growth block.

Practical Allocation: What the Research Supports

The academic literature on international diversification generally supports an international allocation for US-based investors, though the precise optimal percentage is debated and depends heavily on the investor's specific circumstances.

Vanguard's 2023 research on geographic diversification suggested that a US investor who holds only domestic equities forfeits meaningful diversification benefits. Their models supported international allocations in the range of 20-40% of the equity portion of the portfolio.

The historical case, based on Dimson, Marsh, and Staunton's long-run data, shows that globally diversified portfolios have had better risk-adjusted returns than purely domestic portfolios for investors in most countries. The US is unusual in that its domestic equity market has been among the world's best performers over the 20th century -- meaning that a US investor who held only US equities happened to pick the best country to be undiversified in. This should not be mistaken for evidence that concentrated domestic exposure was the correct strategy in advance.

A practical allocation framework:

Within the international allocation, the developed/emerging split in a total international fund like VXUS (approximately 75% developed, 25% emerging) is a reasonable default. Investors who want to limit exposure to emerging market risks -- political, currency, liquidity -- can use a pure developed market fund like SPDW or EFA.

CAPE-based research by Meb Faber and others supports the idea that tilting international allocations toward the cheapest markets on a CAPE basis -- which as of recent years means countries like the UK, Europe broadly, and Japan over the US -- has historically produced better 5-10 year forward returns. This is a more active approach that requires annual rebalancing of country weights and is more appropriate for investors comfortable with tracking error.

Common Counterarguments and the Responses

"US companies are already global, so I don't need international."

This is the most common argument against international diversification. The rebuttal has several layers. First, revenue exposure and equity exposure are not the same thing. When you own Apple, you own the equity of a Delaware corporation, pay taxes in the US, and are subject to US corporate governance law -- regardless of where Apple's revenue comes from. Second, international companies are also global -- Toyota sells cars in the US, Nestle sells food globally, and ASML's semiconductor equipment is used by chip manufacturers worldwide. Third, the sector composition of international markets provides genuine exposure to economic sectors and risk factors that are genuinely underrepresented in the S&P 500.

"International has underperformed for a decade."

True for the period from approximately 2010 to 2020. Not true for the decade before that. The evidence from decades of academic research is that sequential periods of outperformance between US and international markets are long -- 7-12 years is common -- but they do reverse. Investors who abandoned international after the 2000-2009 period of international outperformance and concentrated in US equities just in time to miss the 2010-2019 US run were engaging in the same recency bias.

"Currency risk adds volatility I don't need."

Currency exposure does add short-term volatility. Over 10+ year horizons, academic evidence suggests currency exposure is roughly neutral in expectation -- currencies mean-revert, and the carry cost of hedging roughly offsets the volatility reduction. For long-term investors, hedging currency exposure removes a short-term noise source but does not meaningfully improve long-run risk-adjusted returns.

Conclusion: The Case for Owning the World

The investment case for international developed market exposure is not about believing that Japan or the UK or France will produce dramatically higher returns than the US over the next decade. It is about recognizing that concentrating an equity portfolio in a single country -- even the historically best-performing country -- creates risks that investors are not compensated for bearing, and that the structural valuation discount in international markets represents a historically unusual opportunity cost of remaining fully domestic.

The low-cost ETF landscape makes implementing international diversification straightforward. VXUS at 0.07% for comprehensive global exposure, SPDW at 0.04% for pure developed market exposure, or EFA at 0.32% for the most widely benchmarked EAFE index -- all three provide liquid, diversified, institutionally accessible exposure to markets outside the US.

The foreign tax credit treatment makes taxable accounts the preferred home for international equity ETFs. The valuation gap between US and international markets makes the next decade's starting point more favorable to international than the last decade's starting point was. And the corporate governance reform story in Japan -- combined with structural changes in European capital markets -- provides specific near-term catalysts that EAFE investors are exposed to.

A globally diversified portfolio does not guarantee better returns in any given decade. What it does provide is a more robust structure that does not bet the entire equity allocation on one country continuing its historic outperformance forever.

This content is for educational purposes only and does not constitute personalized investment advice. Fund expense ratios, country weights, and index compositions are approximate and subject to change. Verify current data at the fund provider's website before making investment decisions.