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Investing internationally: Why is geographical diversification important?
Diversification
Key takeaways:
- Geographical diversification means spreading investments across different countries and regions to reduce reliance on a single market. Investing internationally may broaden portfolio exposure, but it cannot prevent losses and global markets can still decline together.
- International investing can provide access to companies, sectors and economic trends that may be less represented in a domestic market. Developed and emerging markets offer different opportunities and risks, with neither guaranteeing stronger performance or greater stability.
- The potential benefits of investing internationally include broader diversification, exposure to global markets, currency diversification and access to unique industries. These benefits depend on factors such as market correlations, currency movements, costs and the specific investments selected.
- International investments involve additional risks, including currency fluctuations, geopolitical developments, different regulatory environments, liquidity constraints and higher transaction or tax costs. These factors can affect returns and should be considered alongside portfolio objectives.
- Determining the appropriate level of geographical diversification depends on the overall portfolio, financial objectives, time horizon, risk tolerance, costs and currency exposure. Regular monitoring and rebalancing may help maintain the intended allocation, although they can also create costs and tax consequences.
Along with spreading exposure across asset classes, sectors and individual companies, investors may also diversify across countries and regions. This can potentially reduce reliance on a single domestic market, although international markets can still fall together and diversification does not prevent losses.
What is geographical diversification?
Geographical diversification means spreading investments across different countries or regions to reduce reliance on any single market and broaden portfolio exposure. Essentially, instead of focusing solely on one country, investors allocate assets in multiple economies.
Markets often behave differently due to unique factors such as politics, economics, and local trends. So, a portfolio limited to one region remains vulnerable to those specific challenges. If markets respond differently to the same economic conditions, international exposure may reduce the effect of weakness in one country. However, it’s possible that several markets can decline at the same time.
International investing can also provide access to companies, sectors and economic trends that are less represented in the domestic market. Developed and emerging markets offer different exposures, but neither provides steady growth or guaranteed higher returns.
Geographical diversification may reduce dependence on a single economy, although its effectiveness depends on the holdings selected, market correlations, costs and currency movements.
Benefits of investing internationally
International investing may broaden portfolio exposure, but the benefits depend on the markets, products, costs and currencies involved. Potential benefits include:
Greater portfolio diversification
International investments can reduce reliance on a domestic market. If different regions respond differently to economic conditions, this may moderate the effect of a local downturn, although global markets can still decline together.
Exposure to global growth
International investing can provide access to economies, companies and sectors that are less represented in the home market. Emerging economies may grow faster during some periods, but economic growth does not automatically translate into investment returns. Emerging markets can also carry greater currency, political and liquidity risks, while developed markets can experience prolonged weakness.
Currency diversification
Foreign-currency exposure can increase or reduce returns when investments are converted back into the investor’s home currency. For example, a weaker euro may increase the euro value of unhedged US assets, while a stronger euro may reduce it. Currency exposure can therefore provide diversification in some circumstances, but it also introduces additional risk.
Access to unique opportunities
Some of the world's most innovative companies and industries may be based outside your home country. Investing can provide access to sectors and companies that may be less represented in the domestic market, such as renewable energy, technology or healthcare.
Mitigation of political and economic risks
Concentrating investments in a single country exposes investors to localised risks such as political instability or economic downturns. Spreading investments across countries may reduce reliance on one political or economic environment, but it cannot always protect a portfolio from global shocks or correlated market declines.
Risks of international investing
International investments come with distinct risks that require careful consideration.
Currency risk
Exchange rate fluctuations affect returns. For example, when the euro appreciates against the US dollar, European investors may see reduced returns on USD-denominated investments. Currency-hedged investment options may reduce some exchange-rate effects, but hedging involves costs and may not remove currency risk completely.
Market accessibility
Foreign markets often have unique trading hours, liquidity levels, and restrictions for international investors. Some countries impose limits on the types of securities non-residents can purchase, complicating access.
Geopolitical and economic risks
Investing in foreign markets could involve exposure to regional political and economic challenges. As a result, emerging markets may carry greater political, regulatory, liquidity and currency risks, although the level and type of risk vary widely by country and investment.
Higher costs
Global investments involve additional expenses, including transaction fees, currency conversion costs, and foreign tax liabilities. These costs should be compared before investing, while tax treatment depends on the investor’s country, account type and personal circumstances.
Different regulatory environments
Regulatory systems in foreign markets may differ significantly, leaving investors with fewer protections or limited legal recourse. Understanding local rules, account protections and the regulations applying to each investment can help investors assess these risks, but it cannot remove them.
Types of international investments
Investors have multiple ways to access international markets, each with unique advantages and considerations. Here are some common ones:
Mutual funds and ETFs
Mutual funds and exchange-traded funds (ETFs) simplify international investing, making them popular choices for both beginners and experienced investors. These funds can provide exposure to different countries, regions or industries, although some international funds are concentrated in a narrow market, sector or theme.
UCITS ETFs are widely available to many European investors, but their objectives, holdings, fees, currency exposure and risks vary. Broad-market funds may cover several developed or emerging markets, while regional or sector funds provide narrower exposure.
Direct stock investments
Buying foreign stocks directly allows investors to precisely target specific companies or industries. A reputable broker, like Saxo, can give European investors access to major international markets, including the US and Asia.
This route appeals to those who want control over their investment choices, such as purchasing shares of US technology leaders or Asian manufacturing giants.
However, direct stock investments require a deeper understanding of market dynamics, including trading hours, liquidity, and local regulations. Direct international share investing also involves company-specific risk and may require closer attention to trading hours, liquidity, taxation, currency conversion and local market rules.
Multinational Corporations (MNCs)
Multinational corporations can provide indirect exposure to overseas revenues while remaining listed in the investor’s domestic market. However, their performance may still depend heavily on one company, sector or home listing. They also remain exposed to currency movements through their international revenues and costs, so they should not be treated as a substitute for a geographically diversified portfolio.
Real estate and alternative investments
International real estate and alternative investments can provide exposure beyond traditional stocks and bonds, but they may introduce additional liquidity, leverage, valuation and regulatory risks. Global Real Estate Investment Trusts (REITs) allow investors to participate in international property markets without owning physical assets. For example, a global REIT might focus on commercial properties across Europe or Asia.
Additionally, emerging-market infrastructure may provide exposure to areas such as renewable energy or transport development. However, these investments can carry significant political, currency, project, liquidity and regulatory risks, and higher economic growth does not guarantee higher investment returns.
Determining the desired level of international exposure
There is no universal percentage of international exposure that suits every investor. The appropriate level depends on the existing portfolio, financial objectives, time horizon, risk tolerance, capacity for loss, costs, tax treatment and currency exposure.
Key factors include:
- Home-market concentration. Investors whose domestic market represents a narrow range of sectors or companies may gain broader exposure through international holdings.
- Regional and sector exposure. Investing in several countries does not necessarily provide effective diversification if the holdings remain concentrated in the same industries or economic drivers.
- Currency exposure. Foreign currencies can increase or reduce returns when investments are translated back into the home currency. Currency-hedged products may reduce some exchange-rate effects, but hedging involves costs and does not remove all currency risk.
- Costs and tax. Trading commissions, fund charges, currency-conversion costs, withholding taxes and other local taxes may affect net returns.
- Risk profile. Developed and emerging markets both carry risk. Emerging markets may involve greater political, regulatory, liquidity and currency risk, while developed markets can also experience substantial and prolonged declines.
The overall allocation should therefore be assessed by looking at how the international holdings interact with the rest of the portfolio rather than by applying a fixed percentage based only on a broad risk label.
Steps for researching international investments
Researching international investments involves considering objectives, products, costs, currencies and market-specific risks. A structured review may include:
1. Define your goals and assess your risk tolerance
Establish clear objectives for international investments. Decide if the focus is on long-term growth, generating income, or both. Align these goals with your willingness to handle risk. The role of developed and emerging markets depends on the investor’s objectives, time horizon, risk tolerance and capacity for loss. Both can experience significant declines.
2. Compare investment options
Choose options that match your objectives:
- Mutual funds and ETFs can provide broad or targeted international exposure, but holdings, concentration and fees vary.
- Direct shares provide company-specific exposure and generally require more research.
- Global REITs and other alternatives may provide different sources of exposure, but they can add liquidity, leverage or market risks.
3. Use a reliable platform
Access to international markets requires a dependable trading platform. Saxo provides access to a range of international markets and investment products. Availability, fees, currency conversion costs, and investor protections vary by market and instrument.
4. Monitor and rebalance your portfolio
Periodic reviews can help assess whether international exposure still matches the intended strategy. Rebalancing may restore the target allocation, but it can also create trading costs and tax consequences.
5. Stay informed about global developments
Economic trends, political events and regulatory changes can affect international investments. Staying informed may support decision-making, but it does not remove risk or reliably identify future opportunities.
Conclusion: The role of geographical diversification
Spreading investments across countries may reduce dependence on one domestic market and provide access to a wider range of companies, sectors and economies. The benefit depends on how the holdings interact. International markets can still decline together.
International exposure also introduces currency, political, regulatory and cost risks. Developed and emerging markets can both play a role in a diversified portfolio, but neither guarantees stability, higher returns or protection from losses.