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Investors dissatisfied with domestic returns have been seeking
greater growth in foreign markets. As noted in last week’s article,
the growth of emerging markets is not a short-term fad, but a
long-term trend that will affect global markets for years to come.
The question then, is how you can take advantage of this opportunity
without losing your shirt. Read on to find out.
The returns of foreign emerging markets are truly
impressive—20%-100% a year or more isn’t uncommon. Who wouldn’t want
to earn 83% in one year like the China index FXI did? Or the 58% it
did in 2007! These dramatic returns have caused some investors to
throw caution to the wind. They’ve moved significant portions of
their portfolios to these markets only to suffer devastating losses.
That’s not what I want for my clients, nor do I want it to happen to
you. While the returns are much higher, the risk is also much
greater. Unless you have carefully planned how to control that risk
then you should leave these markets to the professionals.
Here’s the real question. Are you willing to endure losses of 20-50%
that can last for months in order to achieve those stellar returns?
Most are not. They jump into these markets only to get discouraged
and sell after a big decline. The China index (FXI) is down over 30%
since its peak in October of 2007. Would you still be hanging on to
it?
Daily swings of 5% to 8% are not uncommon for large-cap Chinese
stocks. Newer markets, like those in Vietnam, can take huge dives
very quickly. Governments, along with their financial regulations,
can change overnight. Growing pains are common for developing
markets and those with the stomach to handle the wild ride can be
richly rewarded. Clearly, investors have to match their foreign
exposure to their appetite for risk.
Investing in emerging markets is not for the faint of heart. That
doesn’t mean that you shouldn’t do it. Start small by only investing
a couple of percent of your overall portfolio. Then you need to
decide the method of investing that is best for you.
There are several ways you can invest in foreign and emerging
markets. You can buy individual stocks on the foreign exchange. You
can buy foreign companies that are listed on U.S. exchanges. There
are exchange-traded funds (ETFs) for just about every country and/or
region. There are mutual funds. You can buy bonds as well as stocks.
I only recommend buying stocks on a foreign exchange for advanced,
sophisticated investors. This isn’t as hard as it used to be thanks
to online brokerage firms, but is still pretty involved. First, the
markets like the Hong Kong exchange are located half-way around the
world. That means their market is open while it’s nighttime here.
Second, you have to convert your money to the local currency prior
to making a purchase.
It’s much easier to buy large foreign companies that trade on U.S.
exchanges. Doing so isn’t any different than buying any other U.S.
stock. Some of these companies trade on the pink sheets. If you go
this route, beware of the daily trading volume and the spread (the
difference between the bid and ask price).
Good quality mutual funds are perhaps the most popular way to invest
outside the United States. There are too many choices to list here
and doing your research before you invest is crucial. Some have
active management, while others are more passive. Some focus on
specific markets while others are more general in nature. Fees can
vary widely as well.
No matter how you invest, one major risk to consider is currency
risk. When the U.S. dollar is falling, foreign returns benefit. When
the dollar is rising, however, foreign returns suffer. This means
your return can either be wiped out or greatly boosted, depending on
what the currency markets are doing.
While the superlative performance of emerging markets is long term
trend, many tactical decisions will need to be made along the way.
There are simply too many changes in the governments, rules and
regulations and the economies themselves to just set it and forget
it. Professional management can add significant value and help you
take full advantage of the opportunities that are available.
Nationally-syndicated financial columnist and Certified Financial
Planner® Jeffrey Voudrie provides personal, in-depth money
management services and advice to select private clients throughout
the USA. |
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