Why You Should Diversify with International Trading
Diversification is arguably the most cited rule for investors to follow when building a portfolio. It reduces the risk of a single event or under-performing sector to derail your entire investment portfolio. It follows the adage, “don’t put all your eggs in one basket.”
Once you have a mix of stocks in your portfolio ranging in size and industry, you might think you have risk successfully under control. But regional risks associated with a single country or economy can cause entire markets to fall. In order to alleviate regional risk, you’ll need to expand outside of the country to include international investments.
Investing overseas can seem like a daunting task. After all, while you might be familiar with many of the names in your domestic portfolio, trying to choose a company from overseas you’ve never heard of seems like an unwise decision.
Unless you’re fairly familiar with a certain region, it’s probably best not to try and pick individual stocks outside of the United States. Not only will you not know the brands or trends, but foreign companies often have different accounting rules, making it hard to find intrinsic value and perform proper due diligence.
Instead, you can invest in an international mutual fund. Using a mutual fund to gain access to foreign markets is advantageous because it comes with a diverse portfolio of international holdings, along with professional management, so you don’t have to be familiar with each asset. In a way, you can essentially outsource your investment portfolio to professionals who are familiar with international markets.
If mutual funds don’t appeal to you, you can use ETFs to gain international exposure. Since they trade like stocks, you have more liquidity in your portfolio, allowing you to make quick decisions and change where you keep your foreign assets to easily adapt to market changes. You can gain a diversified portfolio similar to mutual funds, but you may not get active management with an ETF. Keeping a close eye on any ETFs with foreign holdings is necessary, though, as foreign stocks are usually more risky.
Finally, there’s another way to gain access to international markets without really leaving the domestic market. Many large American companies do business overseas and can give investors exposure to those market just by investing in the company. Companies like Caterpillar, Amazon, Ford and many others earn a large share of their profits form markets outside the United States.
Noted investor and founder of the Vanguard Group, John Bogle, is well known for his belief that international diversification isn’t necessary. He said that domestic investments should give investors enough diversification without taking on the additional risks that come with investing overseas. However, the globalization of the world economy means it might now be necessary to invest overseas, as well as domestically. Either way, staying as diversified as you can is the best way to mitigate risks and keep profits coming in.