Managing Your Investment Portfolio: Part Seven
Global Allocations
by Gerald Townsend, Financial Editor
July 2010
In our series on "Managing Your Investment Portfolio," we’ve discussed the importance of setting goals, knowing your tolerance and capacity for risk, developing an investment policy statement, and the concept of asset allocation. This month we open the window wide and consider global allocations.
Why should anyone invest outside the U.S.? After all, there’s plenty to choose from here and isn’t there already enough risk and things to worry about on the home front? Why look for trouble elsewhere? First of all, you don’t really have a choice. Even if you confine your investments to U.S. stocks, you are still investing globally. The companies in the S&P 500 index derive about half their revenues from foreign sources. With a growing worldwide middle class, this percentage will certainly be increasing.
U.S. stocks dominate equities markets, accounting for half the value of the world’s stock market value. On the other hand, this means that the other half of the opportunities are beyond our borders. Having a bigger pool of talent to choose from is one reason to grab your passport and let your portfolio travel overseas.
Another reason is growth. The U.S. is a huge, developed country and can only grow so fast. Western Europe, Japan, Canada, Australia and others are also classified as "developed." However, countries in the "emerging markets" group — such as Brazil, Russia, India, China, Korea, Israel, Mexico, etc. — are experiencing more rapid economic growth. These emerging economies tend to have growing populations, rising income, and improvements in their living standards. Their currencies and political structures, while still shaky at times, are relatively stable. Markets reward countries — and companies — exhibiting sustained and higher rates of growth. It is easier for a speedboat to quickly turn and accelerate than for a battleship to do so, and these emerging markets are speedboats.
However, it is also easier for a speedboat to sink. In the 1980s these emerging markets were renamed "submerging markets" when the speedboat appeared to have sprung a leak. Certainly, emerging markets are more volatile than the U.S. or more developed foreign markets — but that goes along with their higher potential.
If your taste buds lean to even spicier food, take a trip to the "frontier markets." These are small, unstable, underdeveloped countries with volatile and changeable economic and political climates. Many countries in Eastern Europe, the Middle East, and Africa fall into this category.
Historically, one of the arguments for diversifying your investments internationally was to benefit from the fact that markets would not all be moving up or down at the same time. While there is still some truth in this, today’s markets exhibit much higher "correlation," particularly on the downside, which means their movements tend to be more aligned.
How much of your portfolio should be invested in foreign markets? Consider a minimum allocation of 25% and a maximum of 50% as a general guide.
There are many ways to accomplish your foreign investing. You could purchase shares of foreign stock overseas or in a U.S. brokerage account. Many companies offer "American Depository Shares" that more easily trade on the U.S. market and are priced in U.S. dollars. Of course, there are also numerous international mutual funds and many exchange-traded funds.
Finally, why limit yourself just to foreign stocks? Foreign bonds also provide some diversification benefits as well as a way to hedge against the U.S dollar. Yes, they have risks, but so do U.S. bonds.
Gerald A. Townsend, CPA/PFS, CFP®, CFA® is president of Townsend Asset Managment Corp., a registered investment advisory firm. Email: Gerald@AssetMgr.com