By investing in diverse global markets, you can benefit from economic growth in different regions, hedge against domestic market volatility and gain access to a wider range of investment opportunities. The benefits of international diversification also include exposure to different currencies, which can enhance returns and provide a buffer against inflation. Embracing this approach can help create a more resilient portfolio, capable of weathering various economic cycles and geopolitical events. But as with any investment strategy or decision, international diversification has its potential downsides that you’ll also want to consider.
A financial advisor can help you diversify your portfolio and seek out investment opportunities that align with your needs.
Understanding International Diversification
International diversification is a strategy for spreading investments across various geographic regions outside one’s home country. This approach aims to reduce risk by investing in different economies that may not be affected by the same economic events simultaneously. For example, while one country’s market may be experiencing a downturn, another’s might be thriving, thus balancing potential losses.
Investing globally allows individuals to tap into growth opportunities that are not available domestically. Different countries and regions offer access to unique industries and companies, providing a broader range of investment options. This can lead to a more robust and resilient portfolio, as it is not solely dependent on the economic conditions of a single country.
Moreover, international diversification can protect against currency fluctuations. By holding assets in multiple currencies, investors can potentially offset the negative impact of a declining home currency. This is particularly beneficial in times of economic uncertainty or when inflation erodes the purchasing power of the local currency.
Benefits of International Diversification
Expanding your investment horizons to include international assets can significantly enhance your portfolio’s performance. It allows you to capitalize on growth opportunities in various economies, reducing reliance on any single market. This strategy can not only mitigate risks associated with domestic downturns but also open the door to a broader spectrum of potential gains. Here are five general benefits to consider:
- Enhanced growth potential. By tapping into emerging markets and established economies outside your home country, you gain access to industries and companies that may be experiencing higher growth rates. This broader exposure can lead to improved returns, especially when domestic markets are underperforming.
- Risk reduction. Diversifying internationally helps reduce overall investment risk. Different countries often have varying economic cycles, political climates and market conditions. When one region faces economic downturns or instability, investments in other regions can offset potential losses. This geographical spread mitigates the impact of local downturns on your portfolio.
- Currency diversification. International investments also offer currency diversification. Holding assets in various currencies can protect against currency risk and inflation in your home country. If your domestic currency weakens, foreign investments can benefit from favorable exchange rate movements, adding another layer of financial stability.
- Access to unique opportunities. International diversification provides access to unique investment opportunities that may not be available domestically. Different markets have different strengths – such as technological innovation in Asia or natural resources in Latin America. This variety allows you to invest in sectors and companies with specific strengths, broadening your investment horizon and potentially increasing returns.
- Improved portfolio resilience. An internationally diversified portfolio is more resilient in the face of global economic changes. By spreading investments across various regions, you may be better equipped to handle economic shocks, policy changes and market volatility. This resilience helps maintain a more stable and robust portfolio over time.
Risks of International Diversification
International diversification can expose investors to various risks that may not be immediately apparent. Proper research and a thorough understanding of the foreign markets in which they are investing are needed to manage these potential drawbacks effectively. Here are four things to look out for:
- Currency risk: When investing in foreign markets, currency fluctuations can significantly impact returns. An appreciating domestic currency can erode the value of foreign investments, reducing overall gains.
- Political risk: Political instability, changes in government policies or geopolitical tensions in a foreign country can adversely affect investments. These events can lead to market volatility, sudden changes in asset values and unexpected losses.
- Economic risk: Economic downturns, inflation or recessions in other countries can affect the performance of foreign investments. Different countries have varying economic cycles, and downturns in one region can negatively impact an investor’s portfolio.
- Market liquidity: Some international markets may have lower liquidity compared to domestic markets, making it challenging to buy or sell investments without affecting their prices. Limited liquidity can lead to higher transaction costs and difficulty in executing trades efficiently.
Ways to Internationally Diversify Your Portfolio
Whether through direct investments in foreign companies, mutual funds, exchange-traded funds (ETFs), or real estate investment trusts (REITs), investors can access a wide array of international assets. Here’s a look at different foreign portfolio investments you may consider:
- Equity investments. Incorporating international stocks is a common way to build a more internationally diverse portfolio. Investors can purchase shares of foreign companies directly or through mutual funds and exchange-traded funds (ETFs) that focus on specific regions or countries. For instance, Vanguard FTSE All-World ex-US ETF (VEU) provides exposure to both developed and emerging markets, excluding the United States.
- Fixed-income assets. Diversifying with foreign bonds can further stabilize a portfolio. These bonds can be purchased individually or through mutual funds and ETFs, such as the iShares International Treasury Bond ETF (IGOV), which includes government bonds from various developed countries. This adds a layer of protection against interest rate fluctuations and local market downturns.
- Emerging markets. Emerging markets present unique growth opportunities due to their rapidly expanding economies. Investments in countries like India, Brazil and China can be accessed through ETFs like the iShares MSCI Emerging Markets ETF (EEM). These markets can enhance portfolio returns but also come with higher volatility.
- Real estate. Foreign real estate is another avenue for international diversification. Investors can explore global real estate investment trusts (REITs) such as the Vanguard Global ex-U.S. Real Estate ETF (VNQI). These REITs provide exposure to commercial and residential properties outside the U.S., offering a hedge against domestic market downturns.
- Currencies. Investing internationally also introduces currency risk. To manage this, investors might consider currency-hedged funds, which aim to minimize the impact of exchange rate fluctuations. The WisdomTree International Hedged Equity Fund (HEDJ) is one example, offering exposure to dividend-paying companies in developed countries, excluding the U.S. and Canada, while mitigating currency risk.
Bottom Line
Incorporating international assets into your investment strategy can potentially enhance your portfolio’s resilience and generate additional growth. Tapping into diverse economic regions can allow you to capitalize on various growth opportunities, hedge against domestic market volatility and gain exposure to different currencies. However, it’s crucial to understand and manage the inherent risks, such as currency fluctuations and political instability.
Investing Tips
- Whether you’re looking to build a diversified portfolio or invest in a particular type of asset, a financial advisor can potentially help. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- SmartAsset’s asset allocation calculator can help you determine how to spread your money across stocks, bonds and cash based on your risk tolerance. This free tool will even suggest the different categories of stocks to consider, from large-cap to emerging markets.
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