Q. I’m 50 and I hope to retire at 60. How much of my portfolio should be in international investments, and with what focus?
— Trying to prepare
A. We’re glad to hear you’re saving and investing, but the answer to your question isn’t that simple.
For starters, keep in mind that all markets are very volatile in the wake of Brexit — the United Kingdom’s vote to leave the European Union — but we’re sticking with long-term views here.
How much of your portfolio should be invested internationally depends on many factors, including how much you’ve saved for retirement, how much you plan to invest over the next 10 years, your risk tolerance and more.
Because you’re getting closer to retirement, we recommend you sit with a financial adviser who can go over the specifics of your situation. But here are some things to consider about international investing.
All investments have some risk, but international investments have some extra risks, said Roy Williams, president and founder of Prestige Wealth Management in Flemington and Millburn, New Jersey.
He said currency risk, political risk, interest rate risk — as well similar systematic risk found in domestic investments — must be considered before making any international investment.
For example, he said, if you have a European investment that is purchased by converting your dollars to euros and then the euro weakens by 5% relative to the dollar over your investment period, then this loss of 5% could make your investment a poor one.
Karl Graf, a certified financial planner and certified public accountant with Modera Wealth Management in Westwood, New Jersey, said investing internationally will diversify your investments in order to improve the expected risk-adjusted return of the portfolio. This is accomplished over time because international stocks and bonds do not react in the same way, nor to the same degree as their U.S. counterparts in the same circumstances, he said.
This difference is what provides the diversification benefit.
“If all your investments react in the same way — are highly correlated — the risk of your overall portfolio increases,” Graf said. “To the extent you can add investments that have do not always react the same way — low correlation — you lower the overall risk of your portfolio which over time improves the chances of you achieving your goals.”
Over longer periods of time, global portfolios — ones with both domestic and international investments — have tended to provide a bit more risk-adjusted returns than an all U.S. portfolios, Graf said. He said the unpredictability of the investment markets from year-to-year also point to the benefits of diversifying into international markets.
“Much has been said in recent years about the reduced value of diversification as globalization has tended to increase the correlation between U.S. and international markets, and this is true to a point, particularly in the developed international markets (much of Europe) for example,” he said. “That said, there still is a benefit to diversifying internationally (even in the developed markets).”
Graf said the wide range of returns between international and U.S. equities in recent years attest to that.
One big factor in this is the impact of currency fluctuations – another diversifying factor.
He said some investors take a different tack by investing in large U.S. equities that have significant international operations. Such stocks tend to hedge the impact of currency fluctuations, which is one reason they tend to be very highly correlated to the U.S. market as a whole — thus largely negating the whole point of investing internationally.
Additionally, investing in emerging markets — defined as a developing countries — would be expected to provide higher returns over time but do have much greater risk.
Graf said the so-called BRICS (Brazil, Russia, India, China and South Africa) are a good example of the volatility of emerging markets.
“It was not long ago that these countries were the darlings of many investors but more recently they have as a group suffered significant reverses that are likely to linger for quite some time,” he said. “For this reason, when investing in emerging markets, it is advisable to invest a relatively small portion of your portfolio and make sure the investment is well-diversified over the entire emerging market asset class.”
Williams said you should take a look at the stock market on a global scale. This is because many investors like their portfolios to compare to the global market or at least use this as a benchmark.
The U.S. stock market cap makes up about 52% of the world economy, Williams said. Some of the remaining 48% of the world cap may be in areas that you wouldn’t want to invest in.
“Many emerging markets may present too much risk for the potential return,” Williams said. “For this reason, even the most aggressive investor would avoid these areas.”
Then there are mutual funds, which are themselves designed as global portfolios. Some typically invest anywhere from 10% to 30% in international securities, Williams said, varying this allocation depending on their research, global trends and perceived risks looking forward.
Graf said you need to be prepared for significant ups and downs and have the time frame and the fortitude to ride out the volatile times, he said.
So how much should you invest internationally?
Again, it depends on your personal situation, but Graf said a range of between 20% and 40% of your total equity allocation can go to international markets, with emerging markets roughly one-quarter of that.
Navigating international waters can prove costly if done without proper knowledge, so you may want to leverage an expert for this, Williams said.
“What it comes down to is the right exposure to international investments is different for everyone,” he said. “You want to consider your risk tolerance and the return that your portfolio will need to generate to achieve your retirement at the age of 60.”
That’s where an adviser can help.
[Editor’s Note: You can monitor your financial goals, like building a good credit score, each month on Credit.com.]
More Money-Saving Reads: