Where Most of Your Future Portfolio Gains Will Come From

The trend is up.

This may sound odd. After all, a lot of investors are pretty gloomy these days.

In America, house prices continue to head south…about 1 in 10 people remain unemployed… and Washington is in disarray over what to do about its spiraling debt problem.

But investors who only see doom and gloom are likely suffering from a peculiar condition. Something called “home bias.”

Most of us consider ourselves unbiased. But when it comes to investing, many of us are more biased than we think.

Although investing in overseas markets lowers the amount of risk in a portfolio by spreading risk around different countries and regions, surprisingly few people take time to create globally diversified portfolios.

And I’m not just talking about Americans…

Sweden’s Crazy Investors

One study from the late 1980s showed that Swedish investors put nearly all of their money into domestic stocks even though the Swedish stock market represented only about 1% of the world’s total market value of stocks.

Journal of Banking and Finance article found that the less sophisticated investors were, the more likely it was that they’d succumb to home bias.

The article identified the type of individual with the highest likelihood of home bias as “an older, unmarried, poorly educated man working for the government, who invests only a small amount of money, and who has no experience with risky investments outside the pension plan.”

Women, according to the article, are less prone to home bias than men. That’s because men are more likely to be overconfident about their investments than women.

This causes men to heavily overweight their portfolios toward domestic stocks and ignore fast-growing economies outside of their home countries.

Think of these biased investors as drunks searching for their keys under a lamppost. They are searching there not because that is where their keys are, but because that is where the light is.

Same goes for the investing world.

Many Americans put their money in home stocks not because those stocks offer the best growth prospects but because that is where the light is shining – the local media covers local markets… their brokers favor local stocks… and their friends and neighbors do, too.

Seen through this lens, it’s hardly a surprise that a lot of investors are glum right now. Like the drunk under the lamppost, they are looking for opportunity in the wrong place – the world’s developed markets.

And they are ignoring the real opportunities in the world beyond America’s borders. In fact, they are ignoring the trend where most of the money they’ll ever make in stocks will come from.

Don’t Underestimate the “Super Cycle”

As I said on Monday, the expanding middle class in emerging economies along with rapid urbanization and industrialization is creating a “super cycle” of growth that will likely last many decades.

What we’re talking about here is a prolonged period in which global economic growth shifts from developed nations in Europe and North America to Asia and South America.

Investors who truly understand the potential of this shift will prosper. Those suffering from home bias will struggle to keep up with taxes and inflation. Most likely their U.S.-only portfolios will lose money over time.

It doesn’t take a big leap of the imagination to see how the growth of the emerging market middle class will benefit companies based in emerging Asia and Latin America.

And it doesn’t take an investment genius to understand that the companies that will benefit most will be those that generate most of their revenues in emerging economies.

Sure, there are major challenges ahead, as the world struggles to shake off the effects of the financial crisis. And there will be causalities – particularly in countries in the developed world with too much debt and not enough growth.

How to Play It

But these challenges are masking the huge upside potential in the global economy as the super cycle in growth driven by the emerging world picks up speed.

One of the best ways to play this growth is to target the rising consumer class in emerging economies.

You don’t have to be a stock picker to do this. One exchange-traded fund, the WisdomTree Emerging Markets Small-Cap Dividend Fund (NYSE:DGS), does the work for you.

Shares of DGS are up 4.5% since the fund was launched in October 2007, according to Bloomberg. And fees are a reasonable 0.63% a year.

One in four dollars of this ETF’s portfolio is invested in consumer staple and consumer discretionary companies in emerging countries.

If you want to get close to the rise in the emerging market middle class, these are the companies you want to target.