The link between economic freedom and prosperity is a well-documented reality. This means that, when diversifying your portfolio with foreign holdings, you should look to the worlds freest economies.

Here is a simple thought experiment. Would you rather invest in South Korea, a world leader in electronics, telecommunications, automobile production, and shipbuilding, or in North Korea, where corruption is endemic at every level of the state and economy?

The Heritage Foundation, which ranks countries by economic freedom for the past 20 years, constantly shows that free markets produce better economies. They allocate resources more efficiently. A centralized planner cannot know and respond to all of the signals as quickly as the free markets.

For over a decade, we have advocated freedom investing, the idea that investing in countries rated high in economic freedom should produce better returns than in those with more controlled or repressed economies.

This investment strategy has proved to be successful. The freest six countries we call them the free six were Hong Kong, Singapore, Australia, New Zealand, Switzerland and Canada. The return of each of the free six indexes beat the return of the foreign developed markets index, MSCI EAFE.

You cant invest directly in an index, but you can invest in a product that attempts to track an index. In 2014, the average net return of iShares MSCI funds that track the free six indexes (EWH, EWS, EWA, ENZL, EWL, EWC) was 2.88%, outperforming the EAFE fund (EFA), which was in the red, by 7.92 percentage points.

Net returns reflect what remains after the deduction of tax withholding at that countrys maximum appropriate rate. In some countries, such as New Zealand, companies pay their non-domestic shareholders a bonus to compensate for the tax credit that domestic shareholders can claim.

Additionally, the returns are translated into U.S. dollars. This year that conversion hurt foreign stocks as the U.S. dollar appreciated against most currencies. If everything is measured in local currencies, the average return of the free six was much higher, 10.44%.

One more reason that makes the free six great investments is these currencies hold their value better when the dollar strengthens. Over 2014, the dollar strengthened an average of 12.79%, according to the U.S. Dollar Index, but only an average of 6.52% against the currency of the free six.

The United States used to be economically free, but fell one tier to mostly free in 2010. Still, it is the 12th freest country in the world. Also, because currency exchange is not an issue, domestic investments remain a large share of our asset allocation. For the portion of foreign stocks, we weight those countries ranked free over those with lower scores.

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Freedom Investing Success