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Why Global Diversification Still Makes Sense

Some U.S. investors are still averse to investing outside their own country. Their reluctance is fueled by a variety of assumptions, three of which in particular warrant a closer look:

Assumption: Investing in U.S. multinational companies provides exposure to overseas markets without the risk.

Reality: To an extent, this is true. However, investing solely in U.S. companies entails its own form of risk, because it can lead to an under-diversified portfolio.                                                                                

Assumption: In this era of globalization, U.S. and international equity markets move in the same direction simultaneously. So it matters not whether you limit yourself to U.S. investments or invest globally.

Reality: The belief that U.S. and international equity markets move in lockstep is widely held, but it’s not supported by past performance. When individual stocks of companies around the world have similar risk, the stocks do have the same expected rate of return. However, the stocks don’t all get to that return in the same manner or at the same time. A study of investment results from January 1970 through December 2012 showed significantly dissimilar price movements between U.S. and international equity markets.         

Assumption: International stocks, especially those in emerging markets, are risky.

Reality: It’s true that these stocks pose a higher level of market risk. But a willingness to assume risk opens up opportunities to earn higher returns.

Investment results in 2012 reminded us that international investments are worth serious consideration. In international markets, developed market equities (up 17.9 percent) and emerging market equities (up 18.6 percent) again posted higher returns than U.S. equities (up 16.0 percent).

Also, take a look at the table below, which shows annualized returns for the ten-year period ending December 2012. The S&P 500 represents large-cap corporations that are mostly American, and the MSCI EAFE and Emerging Markets indexes represent foreign stocks. The foreign indexes performed significantly better:

At Grand Wealth Management, we believe that stocks of international developed and emerging markets have a place in a well-diversified portfolio. We can help our clients decide how much to allocate to international stocks, based on clients’ personal goals, time horizon and risk tolerance.

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