If you had to rank domestic large-cap stocks, corporate bonds, 30-day Treasury bills, and global stocks according to their risk levels, which one would you say carries the greatest risks? Given the perilous state of the world economy during the past several months, most people would probably say global stocks.
If you had to rank these same asset classes according to performance, which would you say was the top performer? Over the past 40 years, it was global stocks, despite losing an incredible 43% of their value in 2008 (see graph). Over the long term, global stocks and the S&P 500 have experienced comparable gains, but in any given year they may turn in disparate performances.
If your portfolio doesn’t include some global equities, it might be missing a key dimension. Global investing carries significant risks that are not to be taken lightly, so it is not appropriate for everyone. It’s a good idea to consider whether you are comfortable with the risks before you pursue the potential rewards.
Globalization vs. Political Instability
Developments in technology and trade agreements have opened new markets and opportunities for the world’s economies, whether they are emerging or already industrialized. However, not all nations are able to enforce contract and property rights to the same degree that has made the United States such a great place to invest. A decision to invest in another country must begin with an understanding of the political and economic forces at work in the region.
Diversification vs. Currency Fluctuations
The dollar has a record of stability that is hard to match, but its recent weakness is a reminder that dollar-denominated investments can be risky, too. Investing abroad offers the opportunity to help manage these risks by spreading them across multiple economies and currencies.
However, currency fluctuations also pose risks. If an investor’s domestic currency is strong against a foreign currency, the investor may be able to gain purchasing power when exchanging to the weaker currency. But if the foreign currency continues to weaken, any investment gains and the principal may lose value when exchanged back into the domestic currency. Staying abreast of the forces that influence a particular currency’s value is essential to successful global investing.
Stellar Potential vs. Financial Reporting
The greatest return potential is frequently associated with the greatest risks. This is true whether you are talking about a start-up company or a fledgling economy. Because the U.S. economy is mature, its accounting standards are among the most rigorous in the world. Growing economies are often marked by lax accounting standards, which can make it more complicated to perform the due diligence that is essential to finding sound investment opportunities.
The risks of global investing are numerous, but so are the potential opportunities. A decision to pursue foreign investment opportunities should begin with a thorough examination of your risk tolerance.