Although many investors understand the importance of diversification, the average investor’s portfolio is 80% allocated to domestic opportunities.1 When you consider that the United States represents approximately 65% 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.2
Read on to learn several key benefits to international diversification.
Key Takeaways
- Many investors understand the importance of portfolio diversification, but most are heavily weighted in U.S. markets.
- There are several key benefits to global investment diversification, including enhanced return potential, risk mitigation and reduced volatility.
- An experienced wealth manager can help you navigate the complexities of establishing a globally diversified investment portfolio.
Benefit #1 – Enhanced long-term return potential
Investing in multiple countries across various market capitalizations offers an opportunity to gain access to unique growth opportunities not available in the United States.
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, including the U.S. 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.
Benefit #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.
A great 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% during that period.3 Investors who were only concentrated in large companies in the U.S. market would have seen their portfolio stagnate over this 10-year period, but those who were diversified in international markets across companies of various sizes were able to participate in higher international returns.4
Benefit #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.
Benefit #4 – Protection from currency fluctuations and inflation
The diversification benefits of a global investment portfolio can provide protection from both currency fluctuations and inflation by spreading out your investments across different countries and multiple economies with different characteristics.
The following global diversification tips can help you get started building diversification internationally.
Tip #1 – Consider your risk tolerance and investment goals.
Before you make a move to improve your global investment allocation, it’s important to carefully consider your level of comfort with risk and what investment goals you’re hoping to achieve. Are you investing for retirement? Do you hope to save for a large purchase, such as a home or a child’s college education? Your specific goals will impact your investment timeline as well as the level of risk you can take on.
Tip #2 – Determine what types of investment vehicles and asset classes best meet your needs.
Once you’ve considered your risk tolerance and investment goals, consider what types of international investment vehicles and asset classes best meet your needs. Investment vehicle options include:
- Mutual funds and exchange-traded funds (ETFs) – These are pooled investment vehicles that can provide diversification within a single investment and allow you to access global diversification across various regions, industries and market capitalizations. Mutual funds and exchange-traded funds can be actively managed or track an index.
- Index funds – Index funds are a type of mutual fund or ETF that replicates the performance of a designated market index, such as the MSCI EAFE Index or the FTSE All-World Index. They offer the diversification benefits of a mutual fund or ETF; however, because they track a market index and aren’t actively managed like some mutual funds and ETFs, they typically have lower expense ratios and offer a higher chance of achieving market returns over the long term than an actively managed fund.
- Individual stocks and bonds – Investing in individual stocks and bonds across various geographic regions and sectors is another way to achieve global diversification. However, international investments aren’t always as accessible to average investors, as some don’t trade on domestic exchanges. Additionally, this approach comes with additional risks, because the performance of a single investment can have a much larger impact on performance than a diversified pool of investments. Investors generally need a larger sized portfolio to achieve the same amount of diversification using individual stocks as they can achieve in a smaller portfolio using mutual funds and ETFs.
Tip #3 – Research and monitor.
Once you’ve determined the types of investment vehicles and asset classes that best meet your needs, it’s important to thoroughly research various markets, different industries and the specific investments you may be interested in. Keep in mind that global market events and currency fluctuations may impact your international investments differently than your domestic investments. Diversifying across various currencies and geographic regions can help spread out your risk.
Tip #4 – Regularly rebalance.
It’s important to regularly rebalance your portfolio as assets that have performed well begin to dominate your allocation. Doing so can help ensure you remain true to your investment objectives and risk tolerance. It also helps you follow the number one rule of investing, sell high and buy low, which can be difficult to carry out in practice without a strategy.
Failing to rebalance on a regular basis can result in certain investment types, regions or sectors becoming overweighted, which can lead to unintended concentration risk. On the other hand, regularly rebalancing to your target asset allocation can help lock in gains from top-performing investments while buying underperforming assets when they’re undervalued and also helps ensure your portfolio continues to meet your needs. Rebalancing can even help increase return over the long term when compared with a portfolio that’s not rebalanced.
A big challenge many investors face when establishing a globally diversified investment portfolio is finding the time to research and manage all the moving pieces. International investing comes with additional risks, market exposure and complexities, which is why it’s important to work with a qualified wealth manager to expand your portfolio overseas.
If you could use help establishing a globally diversified portfolio, schedule a call with a member of our team.
