International Investing Part 2 of 2 - The Risks

9 risks to international investing (yes, maybe you should invest a portion of your diversified portfolio internationally but adjust the amount based on these risk factors):

(1) Interest rates globally
(2) GDP year-over-year changes within countries you are considering (growth rates)
(3) Economic future
(4) Central bank's influence
(5) Political stability
(6) Level of exports versus imports (the U.S. exports much less than other countries)
(7) Assets and commodities versus a country's capabilities (their intellectual, service industry)
(8) Debt to GDP (Japan's is 200% for example); also, the current deficit versus their reserves
(9) Per Capita value (not just the population size); for example, much of the world still lives on dollars a day, including China and India though their populations are large

I believe that future growth is, however, in these non-U.S. countries, but stock market performance is based on growth "expectations" not necessarily the actual growth rate.

When looked at through this prism of these nine factors, the U.S. truly does shine in comparison to other countries. Here is the question:

"...If the U.S. is "expected" to grow at a rate of 2% and it grows at greater than this rate, would investors like that better than if an emerging market country's growth rate was "expected" to be 8% but it only grew at 6%?.." Something else to think about.

International Investing

There is much written about investing in international markets.

First, in the developed countries of Europe and Asia and, then, investing in Emerging Markets (like Brazil, Russia, India, China [BRIC for short]). Now, the Frontier Markets (smaller developing countries) are also recommended by many advisors.

The size of the financial markets based on market capitalization, though, reveal an interesting statistic based on 2007 numbers (the numbers are always changing but I just want to make a point):

The United States...is at 47% of the world's market (almost twice the size of the next largest)
Japan.........................is at 26%
U.K. ...........................is at 14%

Note that these 3 countries make up 87% of the world market's financial size (capitalization).

GDP (Gross Domestic Product) is another measure of the financial influence of countries. From that perspective in round numbers (2010 numbers):

European Union........$15 trillion
U.S.............................$14 trillion
China.........................$10 trillion
Japan..........................$ 4 trillion
India............................$ 4 trillion

All other countries are less than $4 trillion each.

Although there is something to be said for investing internationally in developed countries as well as in emerging markets of "developing" countries, please do not lose track of the additional risks involved. These markets are still very small in relation to the world economy (China is the exception now but per capita is yet another story).

I will highlight the risks (including per capita) in my next blog entry.

Lost Money

If you think there is money from an unclaimed pension, life insurance, retirement plan or other asset, then it may be worth researching online. Sites to try:

www.missingmoney.com

www.unclaimed.org

There is the National Association of Unclaimed Property Administrators (NAUPA). Check it out especially for loved ones that may have passed away and not left proper documentation.

REITS - Non-Publicly Traded

Real Estate Investment Trusts (REITS) can be publicly-traded and available as ETF's (Exchange Traded Funds, like stocks), through mutual fund companies or as specific companies.

From my viewpoint, your personal residence may be considered your real estate portion of your portfolio but you cannot rebalance it very well within the context of your other investments. Your personal residence is also not diverse geographically (you have one personal residence) and it is residential when there are other styles of real estate (i.e. industrial, retail, commercial, equity, etc.). Your home also does not pay you rental income or a dividend.

So, there is a legitimate argument for holding some REITS (much of the time, they are less correlated to stocks/bonds) as investments but, keep in mind, that if you own a mutual fund you probably own some real estate companies within it.

Publicly-traded REITS though act more like stocks than inflation-protected real estate, so an alternative may be non-publicly traded REITS. There are privately-held and publicly-held options here. For most, privately-held are out of the price-range of those with less than $5 million or so of investable assets.

Public companies, non-publicly traded have the advantage of not being priced daily (maybe once per year instead) and so are less volatile or so it appears and do pay you a dividend taxed at regular interest income rates. Hold them in retirement accounts.

The disadvantages may outweigh their use:

(1) Illiquid - you may be stick holding one for 7-10 years before being able to sell

(2) Dividend rate originally offered may be changed and even lowered from a 6-7% range to 2-3% if, like now, the economy suffers in the area your REIT is held

(3) Sales charges, high annual fees and depressed values of their holdings may erode your gains

(4) Share value may drop when re-evaluated on a yearly basis (but you are not suppose to worry since you may not be able to sell it anyway)

(5) Public companies are audited but there is always the possibility of accounting shenanigans

Frontier Markets, Emerging Markets - should you?

High quality bonds (Treasuries) and Cash are the most "diversifying" assets available (more so than commodities, emerging markets, international, etc. whose correlations to the US stock market are much higher these days and even higher when markets go down when you want the uncorrelated/diversification the most) but the "expected returns" of high-quality bonds and cash are much less than other more riskier asset classes.

So, should emerging markets and the next level, frontier markets (smaller countries that are just now coming onto the world scene over the past 5 years or so), be considered not only for their uncorrelated opportunity but also for their higher expected return?

Maybe. Again, the percentage of your portfolio that you apply to this should be in the 1-5% range and you want to stay consistent. Not moving in and out but always having a presence once you start. If "emerging markets" did 30%+ (like they have done in the past, ahhh, but past is no indication of the future as we all know) and you have 5% in your portfolio then that is adding another 1.5% to your total return in that year. Don't expect that kind of return consistently.

Cash can't do that, but cash is consistently there (yes, losing purchasing power but also lowering volatility overall). The issue is never maximizing return but rather optimizing return with the amount of risk and time horizon appropriate for you.

Investing in Commodities

Commodities may have a place in a portfolio for the reason that they often go up when stocks go down and go down when stock go up. That makes for diversification and helping to smooth out returns but, remember, trying to time it is not possible on a consistent basis. This chart from wealthdaily.com has only specific time periods and I would prefer to look at other time periods, too. No more than 5%-10% of your portfolio should be here, if used, but for most investors (less than $5 million in assets to invest) it probably is unnecessary.

100 YEARS OF INVESTMENT GENERATIONS

Generation / Commodities / Stocks / Years
1914 – 1930 . . . . - 14% . . . 159% . . . 16
1930 – 1947 . . . . 244% . . . - 30% . . . 17
1947 - 1965 . . . . - 18% . . . 503% . . . 18
1965 - 1981 . . . . 123% . . . 35%** . . . 16
1981 - 1999 . . . . - 9% . . . 1054% . . . 18
1999 - 2016 . . . . ???? . . . ???? . . . . . . 17

** While stocks had a small positive return for 1965-1981, if you adjusted for inflation the number would be negative

Table: WealthDaily.com Data Source: CRB Index / S&P 500 Index