Why should you geographically diversify your portfolio?
What is Geographical diversification, and why is it important?
Diversification is assigning money to a diverse range of investments to minimize risk. It’s akin to not placing eggs in one basket in terms of money.
Purchasing securities from numerous locations is called geographical diversification. Like many advisors may have advised you against keeping all your money in one stock, similarly, you don’t want all your money in one single country or region. Relying on one single means that the stock’s failure would be devastating to your portfolio.
Geographic diversification, like general diversification, is based on the idea that stock markets in different regions aren’t always highly associated.
For example, suppose the stock markets in advanced economies are decreasing due to a recession. In that case, an investor may transfer a portion of his or her holdings to emerging economies with greater growth rates, like China, Brazil, India, Russia, and others. This strategy restores balance to your portfolio.
The pros and cons of global diversification
Expanding a portfolio across several geographic locations can help investors adjust for the fluctuations of a particular financial region, lowering risk over time compared to less diversified portfolios.
Investing in international markets has never been easier, thanks to exchanging traded funds and mutual funds.
Diversifying away from advanced economies has its compensations. Many enterprises in sophisticated markets offer comparable products and services, resulting in fierce competition. On the other hand, developing markets may be less competitive and hence have more room for expansion.
The refute is that the whole world’s marketplace is already interconnected, so dispersing your money across different areas no longer provides the same level of diversification.
Compared to industrialized countries, faster-growing economies may face higher political risk, currency fluctuations, and general market risk.
Exchange rates, for instance, are always changing and can work against you. If the rupee declines, an investment in India, for example, could lose value in dollar terms (This means it takes more rupee to buy a dollar).
On the other hand, investing in different currencies is another strategy to diversify and reduce risk.
Over the previous ten years, India’s share market has generated remarkable gains. It is one of the world’s fastest-growing stock markets, outpacing even the S&P 500. For instance, from August 08’ to August 18, S&P 500 Index increased by 142%, whereas the BSE SENSEX climbed by 188%.
Despite greater return, the SENSEX shows high volatility. Volatility means how risky a particular investment is for the average investor. The risky the investment is, the greater the volatility and the more price movements there are.
The standard deviation of the return is one measure of volatility. Compared to the S&P 500, the SENSEX has more spells of higher volatility.
Minimizing volatility when designing a portfolio can result in a more profitable portfolio. This is the basic argument of the Modern Portfolio Theory, which states that an investor should opt to maximize return for a given level of risk rather than taking a greater risk than would not provide additional gains.
In general, geographical diversification promotes more stable investment returns while lowering the depth and duration of your portfolio’s drawdowns compared to other regional markets.
Given the current state of world geopolitics, which could lead to more diverse outcomes in country investment returns and relatively close to nil interest rates globally, resulting in lower asset yields in the future, geographical diversification is important.
In fact, geographical diversification of your investment portfolio may be the best chance of successfully conserving and growing your wealth for the future.
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