Save. Plan. Invest. Create a budget and make sure to diversify your assets. Whatever you do, always remember the importance of compounding!
As investors, we have heard investment strategies so often that we’ve each formed what seems like our own “perfect” recipe for successful investing. But as time goes on and global markets change, our recipe is bound to change with them, leaving only the key ingredients standing. For example, while investors may leave out a pinch of one asset class or add risk to taste, many consistently keep organized budgeting and market analysis in the mix. Preheat oven to 350?
Here are some reasons why global diversification should always be a crucial ingredient in the time-old recipe for making a strong investment portfolio:
1. One vs. Many
When it comes to global consumer markets, you would be hard-pressed to find one market that consistently outperforms all of the top global markets. This is largely due to the fact that all markets are cyclical – meaning they all experience distinguishable periods of growth and decline. By investing in only one market, you can almost guarantee that your portfolio will perform better than the global average at some times and perform worse than the global average at others. However, if you invest in the markets of multiple countries, you effectively average their performances (probably some better and some worse than the global average), reducing the chances that your portfolio will perform worse than the global market average.
2. Can you beat the markets?
According to MarketWatch, yearly evidence shows that “neither individual nor professional investors can outperform broad market indexes consistently over long periods of time.” This means that as rare as it is for one country’s consumer market to consistently outperform the global market average, it’s even more rare for an investor to consistently choose the markets that perform best. This is due to the fact that market fluctuations result from “all relevant information available to investors.” It is, of course, extremely difficult to always be aware of all of the “relevant information” that drives stock price fluctuations. For this reason, investors should choose stocks from different countries in order to take away the guesswork of choosing which nations’ markets will succeed.
3. Grab your Binoculars and Look to the Emerging Frontier
Look out at the world. Many investors today recognize that, while the US has strong consumer markets, the markets of other countries are rapidly emerging as competitors. For example, the Chinese, Japanese, and German markets all have a more stable place within the top 10 strongest world markets than they did 10 years ago. Furthermore, investors are looking more readily at investing in “emerging markets” and “frontier markets” in developing countries. These markets are expected to grow “two to three times faster than developed nations like the US”, according to the IMF. So, as countries are developing worldwide, they are creating stronger and more profitable investment opportunities for investors.
4. Domestic Correlations vs. Different Countries
According to Barron’s, the returns from two asset classes in the same country are often fairly correlated. For example, the correlation between “US large-cap stocks and US mid-cap stocks in the past 20 years has been 0.95”. If a correlation of 1.0 signifies that the returns from both asset classes fluctuate in the same direction, it is safe to say these asset classes have directionally similar yields. On the other hand, the “correlation between US large-cap stocks and emerging market equities is 0.77”, meaning there is a much weaker correlation. This signifies that investing in US markets, as well as allocating money to emerging market securities, can help investors reduce the overall volatility of their investments by providing varying returns.
5. More Monies, Less Problems
One problem that investors often face is currency risk. Currency risk is defined as the kind of risk on investments that stems from changes in the valuation of currencies. For example, if you are an American investor who invests in China, your dollars are converted into Chinese Yuan. Then, if the Yuan devalues while you’re invested there, you can lose money even if the value of your stock goes up. This is also true for American investors invested in US markets. If the dollar deflates while you hold US investments, you could end up with less purchasing power, even if the value of your stock goes up. Therefore, you might consider holding investments in several different currencies, in order to decrease volatility as currencies change.
Overall, diversifying your assets between different countries can help minimize risk without sacrificing potential returns. You may want to consider global diversification as part of your recipe for investing success!