International Investing: Risks and Rewards
With Russian troops massing near the Ukrainian border as US leaders and Western allies warn of an imminent invasion, it may seem a strange time to be thinking about investing internationally. After all, the unstable situation in Ukraine has been sending shock waves through US markets; the major averages are down 3-5% this past week alone. Surely this isn’t the time to start thinking about sending money overseas?
But for investors who want to improve total return and reduce volatility in their portfolios, the answer is less obvious than one might think. Investment professionals and portfolio managers have known for years that adding an international component to your portfolio is a key to good diversification and reduction of overall portfolio volatility. In fact, according to research from Dimensional Fund Advisors, diversification that includes an international component can deliver more reliable outcomes over time than concentrating assets in a single country—including the United States. After all, some 40% of the available investments in the world represent companies based in other countries. Ask yourself: When you go to the grocery store, do you routinely ignore 40% of the store? Or do you more often peruse the offerings on most of the aisles? Similarly, investors who ignore the opportunities in international markets may be missing out on opportunities that could help them reach their long-term financial goals more securely and with less overall volatility.
The chart above represents the total market capitalization of all publicly traded companies in the world as of December 31, 2020. The largest block is, of course, the US equity market. the yellow boxes represent markets in developed nations outside the US, while the green shapes indicate emerging markets throughout the world. Other markets are shown by the smaller, gray boxes. Stocks of the nearly 17,500 international companies represent a significant proportion of the world’s $74 trillion equity market.
Without question, there are special risk considerations involved with international investing, as indicated at the opening of this article. Foreign companies can be subjected to political, military, and other risks that do not pertain to firms domiciled in the US.
On the other hand, it’s worth considering: Has keeping all their investments stateside insulated US investors from the uncertainties emanating from Ukraine? With the interconnectedness of worldwide financial markets today, one might almost say that some exposure to international risks is almost “baked in” to equities, even those based in the United States.
Of course, there are other risks in international investing: transaction costs, currency fluctuation risk, and liquidity problems—especially with investments in emerging markets—can add to investors’ usual concerns around “everyday” market value fluctuations. Investors should carefully consider these special risks as they evaluate the best way to capture available growth in international markets.
But the rewards should also be considered. The greater diversification available through international investing can sometimes smooth out the volatility of the total portfolio, because when domestic stocks are under pressure, investments in other parts of the world may be enjoying a bull market. Then there’s the growth potential to consider. Just as no one can accurately predict which sector of the US market will outperform in any given year, so no one can predict which part of the international equity market will exhibit the best growth in a particular time period. In fact, in the twenty years from 2000 to 2019, the US equity market delivered the world’s best returns only once: in 2014. As shown by the chart to the left, every other year, some other country’s equity markets had higher overall returns.
As with any investment strategy, international investing should be undertaken only after careful consideration of the risks and assessment of your financial goals. You should especially discuss with your financial advisor ways that you can limit the transaction costs associated with foreign investment. At Bernhardt Wealth Management, we work with clients to decide how and when international investing should figure in their overall investment strategy. To learn more about how we assist our clients with managing their investments, please click here.