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should you continue to diversify your financial portfolio internationally?

Tuesday 25 November, 2008

I perused this article by Carolyn Bigda in the Chicago Tribune Crisis rains on diversification parade which questions “Is diversification (in financial portfolios) dead?”    The implicit assumption in the headline is that American investors should divest themselves of foreign holdings to reduce their diversification.  This would be a mistake for many investors who’ve made a lot of money over the past few years by investing abroad.  As I’m sure any responsible financial planner will tell you, of course diversification is not dead.  This is just another example of irresponsible journalism which questions the “voodoo” of getting involved in foreign markets, in this case in financial investments.  Are foreign investment securities risky?  Yes, because we know less about them.  The tradeoff is the opportunity for greater growth, which is a bit more constrained in the developed world.  Diversification is no guarentee against losses.  Smart investing is at least a small bit of a gamble, & investors have been burned lately by not questioning the assumptions behind many of their investments.  Regardless, the same time-tested tenets hold:  since economic growth is not a 0-sum game, other markets can grow while others shrink.  Other economies are hurt by varying degrees by the economic crisis & thus their financial markets & hence stock share prices change depend on how well each country deals with the crisis.  Although the article closes with a gloomy comparison with the Japanese stock market, 1/2 the article admits that diversification helps long term returns.  Not only should portfolios be diversified geographically, they should be diversified in many other ways as well, for example, in industries, time frames (in expiration dates for some securities), & instruments (stocks vs. bonds, etc.).  To suggest not to diversify in these other dimensions would be considered nonsensical, yet to not diversify geographically is OK?   I think not.  The better question is where, when, & how to invest.  Question transparency, regulation, & liquidity in other places, which are not as open as the US, which offers more of these than anyplace else in the world, but don’t question whether or not to generally diversify foreign investment.  That’s just more anti-foreign rabble rousing.

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One comment

  1. Perhaps Carolyn Bigda and others spreading anti-foreign investment fears need to expand their knowledge base beyond the limited information available on the obscure foreign mining or manufacturing companies. As you mentioned, transparency, liquidity and regulation should be questioned when looking at foreign diversification. Foreign currencies allow investors diversification into an investment vehicle that trades independently of everything else in a typical portfolio. A $3 trillion daily market with the largest worldwide financial institutions trading/hedging positions answers the liquidity question. Information on daily price movement can be found in any financial newspaper. Risk can be mitigated by trading style. If an investor truly believes in the continued long-term growth of a foreign economy, go long that country’s currency. Or for a safer bet, find a quality trading manager who takes advantage of short-term price movements in actively traded currency pairs for foreign diversification.



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