Building an investment portfolio is a complex undertaking. In fact, it can be downright intimidating. Many investors are tempted to stick with the familiar, investing only in their home country and in companies and industries they know well. While this approach is comfortable, it can limit potential growth and increase risk.
Investors willing to look beyond their own borders and explore global markets have access to a much broader range of opportunities. While all investing involves risk and can lose money, international markets can offer access to new growth markets and innovative industries, while potentially offsetting downturns in the domestic market. We think investing globally is more than just a good idea. We believe it can be an essential part of a well-balanced portfolio.
Diversification Is the Foundation of a Robust Portfolio
Diversification is one of the key principles in investing. Simply put, you don’t want all of your eggs in one basket. While the U.S. market might dominate your portfolio, relying solely on domestic securities leaves you vulnerable to country-specific risks. In today’s uncertain environment, it pays to consider that risk. An economic downturn, political upheaval, fluctuations in the value of the U.S. dollar, and myriad other factors could have an outsized impact on a portfolio holding only domestic stocks and bonds.
By investing in global markets, you can spread risk across multiple geographic regions and economies, which may help soften the impact of any domestic downturn. For example, if the U.S. market were to experience a correction, gains in other markets such as Europe, Asia, and Latin America could potentially counterbalance losses.
Although global markets are becoming more correlated due to the interconnectedness of the modern world, many opportunities for diversification remain. Historically Japanese and other Asian markets have been some of the least correlated with the U.S. stock market, based to some degree on geographic distance and cultural differences. European markets, though still with a correlation coefficient well below 1, have been slightly more correlated due to the close trading relationship with the U.S. and overlap in time zone. International diversification may still smooth out the ups and downs of individual markets and help minimize volatility in your portfolio over the long term.1
Emerging Markets Can Offer Opportunity for Growth
Emerging and frontier markets can offer exciting growth opportunities for investors. These economies, including regions such as emerging Asia, sub-Saharan Africa, and Latin America2 are expanding rapidly as their middle classes grow and urbanization accelerates. Companies in these markets are experiencing higher economic growth compared to their developed economy counterparts, making them attractive investment opportunities.
Take India, for example. It’s one of the fastest growing economies in the world and has been projected by many to grow faster than most developed nations in the coming years. Growth is being driven by a young workforce, increasing consumer spending, and advancements in technology.3 Similarly, China’s efforts in renewable energy, electric vehicles, and artificial intelligence are setting the stage for global leadership in these industries. By investing in emerging markets, you can position yourself to benefit the potential growth in these dynamic economies.
Gain Exposure to Innovative Industries Worldwide
Some of the most groundbreaking innovations have happened outside the U.S.
Think about advances in technology, renewable energy, and biotech, for example. Asia is driving change in semiconductors, electric vehicles, and gaming, while Israel is a leader in cybersecurity and software. Europe, home to leaders in the luxury goods sector, is making inroads not only in sustainable fashion, but in green technology as well.
By tapping into global opportunities, you can gain exposure to high-growth sectors and pioneering companies that offer potential for attractive returns.
Currency Offers Another Layer of Diversification
Global investing can also offer benefits from favorable currency movements. When you invest in foreign assets, you gain exposure to different currencies. If the dollar depreciates, the value of international investments could increase when converted into dollar returns. Obviously, the converse is true should the dollar strengthen. Nonetheless, this is another layer of diversification that can help mitigate risk.
Investing Internationally Involves Risk
Investing internationally certainly offers opportunities for increasing diversification and pursuing potential returns. However, it also comes with its own specific risks to consider.
As mentioned above, the value of currencies fluctuates. Exchange rates can swing unpredictably, affecting the value of foreign investments. If the currency of the country in which you are investing weakens against the dollar, your returns may decrease even if the investment performed well locally. Fortunately, there are many hedging strategies that can help mitigate currency risk.
Political stability is another concern, particularly when investing in emerging markets. Governments can undergo sudden changes that introduce volatility, even in countries long considered among the world’s most stable. Strikes, protests, or conflicts may directly affect markets, and it’s crucial to evaluate a country’s political climate before investing.
Transparency can be challenging, particularly in emerging market countries. Companies may be unaccustomed or even hostile to releasing the types of financial information that US investors are accustomed to and that are necessary to conduct a thorough analysis of a company.
Corruption is also a concern in emerging markets, with many companies operating under circumstances where crony capitalism, bribery, nepotism, and profit skimming are all accepted practices. In markets where corrupt practices are customary, enhanced analysis is necessary to make informed investment decisions.
Regulatory differences can also make investing more challenging. Every country has its own rules and regulations, and not all companies conduct financial reporting according to US GAAP. Unique legal frameworks, tax policies, and reporting requirements can all add another layer to analysis. Unfamiliar or shifting regulations can create barriers and unanticipated additional costs.
Finally, economic conditions heavily influence investment outcomes. Factors such as inflation rates, unemployment, or recessions may harm businesses or reduce consumer spending. Emerging economies may offer high growth potential but may be more vulnerable to economic weakness.
Get Started Investing Globally
If you have a solid understanding of the potential rewards and risks of investing globally, it’s not difficult to begin incorporating international exposure into your portfolio. Exchange-traded funds (ETFs) and mutual funds offer some of the easiest paths to global markets. One option is The Motley Fool Global Opportunities ETF (TMFG), which is designed to offer long-term global opportunity by providing exposure to what we believe are high-quality, faster-growing companies across the world.
The Takeaway
The world is more interconnected than ever, and by investing globally you can seek to capitalize on that connectivity. By diversifying your portfolio across borders, you can gain access to new potential sources of growth, mitigate the risk of remaining concentrated in the U.S. market, and tap into innovation happening around the world. You can enhance the potential for returns while building more resilience into your investment strategy.
The world outside the United States has much to offer. Start exploring global opportunities to help create a more diversified and robust portfolio.
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