Diversify Beyond the S&P 500 with European ETFs

This guide explains how to add European ETFs to your portfolio to reduce reliance on US large-cap stocks. You’ll learn what to consider before buying, the steps to select and purchase ETFs, and common pitfalls to avoid. No prior ETF experience is needed, but you should have a brokerage account that offers international ETFs.

What You’ll Need

• A brokerage account that supports trading ETFs (most major online brokers do).
• Access to ETF screening tools (free on most broker platforms or sites like justETF).
• Knowledge of your investment goals, time horizon, and risk tolerance.
• Understanding of currency exchange rates (EUR/USD) and their impact on returns.

Step-by-Step

1. Decide on your target allocation. Determine what percentage of your portfolio you want in European equities. A common starting point is 10–20% of your stock allocation, but this depends on your existing US and global exposure. For example, if you already hold a global fund, it likely contains European stocks, so adjust accordingly.
2. Choose the index you want to track. European ETFs typically track one of these broad indices:
   • MSCI Europe – large and mid-cap stocks from developed European countries (e.g., UK, Germany, France, Switzerland).
   • STOXX Europe 600 – 600 large, mid, and small-cap companies across 17 European countries.
   • FTSE Developed Europe – similar to MSCI Europe but with slightly different country weights.

   For broad diversification, the STOXX Europe 600 or MSCI Europe are good choices.

3. Select an ETF that tracks your chosen index. Look for these key characteristics:
   • Physical vs. synthetic replication: Physical ETFs hold the actual stocks; synthetic use derivatives. Physical is generally simpler and more transparent.
   • Accumulating vs. distributing: Accumulating ETFs reinvest dividends automatically; distributing pay them out. For long-term growth, accumulating is often more tax-efficient, but check your country’s tax rules.
   • Expense ratio (TER): Lower is better. Expect 0.10%–0.30% for broad European ETFs.
   • Fund size and liquidity: Larger funds (over €500 million) tend to have tighter bid-ask spreads.
4. Check the currency exposure. European ETFs are often denominated in EUR, but some are listed in USD (e.g., on US exchanges). If you buy a USD-listed ETF, your returns will be affected by EUR/USD exchange rate movements. Decide if you want that currency risk or prefer to hedge it (some ETFs offer currency-hedged versions). For simplicity, many US investors buy EUR-denominated ETFs and accept the currency fluctuation as part of diversification.
5. Place your order. Log into your brokerage, search for the ETF ticker (e.g., VGK for Vanguard FTSE Europe, or IEV for iShares MSCI Europe), and enter the number of shares you want. Use a limit order to control the price. If your broker charges foreign transaction fees, factor those into the cost.
6. Monitor and rebalance periodically. Check your allocation annually or semi-annually. If European stocks have grown to more than your target percentage, sell some and buy other assets to rebalance. If they’ve dropped, buy more to bring it back up.

Common Mistakes

• Overlapping holdings: Many global ETFs already include European stocks. Adding a European ETF on top can create unintended overweighting. Check your existing funds’ geographic breakdown.
• Ignoring currency risk: A strong dollar can wipe out gains in European stocks even if the underlying companies perform well. Understand this before investing.
• Chasing past performance: European stocks may have underperformed US stocks recently, but that doesn’t mean they will continue to. Focus on diversification benefits, not recent returns.
• Buying a niche ETF thinking it’s broad: Some European ETFs focus on specific countries (e.g., Germany only) or sectors (e.g., healthcare). Read the fund’s description carefully.
• Not checking the TER: A difference of 0.2% in fees may seem small, but over decades it compounds to a significant amount.

Tips

• Use a core-satellite approach: Keep your main portfolio in a low-cost global fund, and add a European ETF as a satellite tilt if you want extra exposure.
• Consider small-cap European ETFs: They can provide even greater diversification away from US mega-caps, but be aware of higher volatility and fees.
• Automate your investments: Set up a recurring purchase to dollar-cost average into your European ETF, reducing the impact of market timing.
• Keep it simple: One broad European ETF is usually enough. Adding multiple European ETFs often just creates overlap.

Troubleshooting

• ETF not available on your broker: Some brokers restrict certain foreign ETFs. Search for an alternative that tracks the same index. For example, if VGK isn’t available, look for IEV or a similar fund.
• Low trading volume: If the ETF has a wide bid-ask spread, use a limit order and be patient. Alternatively, choose a more liquid fund with higher average daily volume.
• Currency conversion fees: If your broker charges high fees for converting USD to EUR, consider buying a USD-listed European ETF (like VGK) instead, which avoids the conversion at purchase time.
• Dividend withholding taxes: Some European countries withhold taxes on dividends paid to foreign investors. This is often unavoidable but can be mitigated by choosing an accumulating ETF, which reinvests dividends without passing them through to you.

Frequently Asked Questions

Are European ETFs a good hedge against a US market downturn?

They can provide some diversification because European markets don’t always move in lockstep with the US. However, in a global crisis, correlations tend to rise, so they are not a perfect hedge.

Should I choose a EUR or USD-denominated European ETF?

If you’re a US investor, a USD-denominated ETF is simpler because you avoid currency conversion at purchase. However, you’ll still be exposed to EUR/USD movements in the underlying assets. A EUR-denominated ETF adds explicit currency risk but can be beneficial if you expect the euro to strengthen.

What’s the difference between MSCI Europe and STOXX Europe 600?

MSCI Europe covers about 440 large and mid-cap stocks from 15 developed countries. STOXX Europe 600 covers 600 stocks from 17 countries, including some smaller caps. The performance is similar, but STOXX has a slightly broader scope.

Do European ETFs pay dividends?

Yes, most do. You can choose between accumulating (dividends reinvested) and distributing (cash paid out) versions. The choice depends on your income needs and tax situation.

Can I buy European ETFs in a retirement account?

Yes, most retirement accounts (like IRAs in the US) allow ETF purchases. Just ensure the ETF is available on your retirement account’s platform.

How often should I rebalance my European ETF allocation?

Annually is sufficient for most investors. Rebalancing too frequently can incur unnecessary trading costs and taxes.

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