Although many investors understand the importance of diversification, the average investor’s portfolio is 80 percent allocated to domestic opportunities. When you consider that the United States represents approximately 65 percent of the global equity market by capitalization, this home-country bias means you could be missing out on more than a third of the world’s investment opportunities if you’re not participating in global markets.
Global investment diversification refers to the strategy of spreading out investment capital across different countries, regions, and industries to reduce reliance on a single market. Investing in both developed and emerging markets can help reduce your portfolio’s risk, mitigate the impact of localized economic downturns, and enhance your long-term return potential. Let’s consider each of these benefits to your portfolio in more detail.
1: Potentially enhanced long-term returns
Investing in multiple countries across various market capitalizations offers an opportunity to gain access to growth opportunities not available in the U.S.
While they come with additional risks and volatility, emerging markets such as India, China, and Brazil have a higher potential for rapid growth compared to other, more developed markets. Additionally, international markets have different distribution across sectors that may be underweight in the domestic market. Over time, investing in international economies at various market capitalizations can lead to enhanced return potential versus a portfolio that’s heavily weighted in U.S. stocks.
2: Short-term risk mitigation
Global diversification can help protect your portfolio from geopolitical events that occur in one specific region. It also provides opportunities to continue growing your investment portfolio during downturns in U.S. markets. Because different markets perform differently at different times, a globally diversified portfolio can reduce the impact of a single market on your overall returns.
An example of diversifying across countries and different company sizes is the lost decade from 2000 to 2009, when the S&P 500 (the index of the 500 largest U.S. companies) had annualized returns of -0.95 percent. Investors who were only concentrated in large companies in the U.S. would have seen their portfolio stagnate over this period, but those who were diversified in international markets across companies of various sizes were able to see higher international returns.
3: Reduced long-term volatility
Different geographic markets often perform differently and experience different economic cycles. Investing in a diversified international portfolio can help reduce volatility and smooth out your long-term returns, because strong performance in one region can help offset underperformance in other regions.
4: Protection from currency fluctuations
Diversification can provide protection from currency fluctuations by spreading out your investments across different countries and multiple economies with different characteristics. Because different regional markets tend to move in opposite directions, when the U.S. dollar weakens, foreign assets have the potential to cushion your portfolio against potential losses, which can help dampen volatility. This has the potential to result in more stable and consistent growth over time.
A Word of Caution
While international investments offer important benefits, they can also carry risks related to political instability, currency fluctuations and reduced liquidity. When investing globally, it’s important to diversify across multiple regions and industries, maintain a long-term perspective and understand the specific risks you may face. An experienced wealth manager can help you incorporate global investments that are in line with your financial goals and overall wealth planning strategies.
AJ Kratz, CFA, CFP, is a Private Wealth Manager and Partner with Creative Planning. Creative Planning is one of the nation’s largest registered investment advisory firms, providing comprehensive wealth management services to help align all elements of a client’s financial life, including investments, taxes, estate planning, and risk management. For more information, or to request a free, no-obligation consultation, visit creativeplanning.com.
This commentary is provided for general information purposes only, should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.