Historical returns are no guarantee of future performance. He is comfortable with equity risk, but would like to improve his returns, or lower his risk. The foreign stocks have both a higher return and risk than our domestic market. You might expect that as we mixed the two together the resulting portfolio combinations would fall on a line connecting them. The combination of lower risk and higher returns is why we feel so strongly that global diversification is essential for all investment portfolios.
International markets have a very low correlation with our domestic markets.
This diversification effect will lower risk at the portfolio level, which is one of the chief advantages offered by Modern Portfolio Theory. Modern Portfolio Theory is certainly a great leap forward in our ability to construct rational investment plans. But like any good tool, it must be used with judgment. And, like any good idea, there will always be someone who will take it to an illogical extreme. It is not a substitute for judgment, and in fact requires great judgment for its proper application.