5 International Investing Tips for Retirees
International investing isn't as risky as you think.
International investments may seem like a risky endeavor following the Greek debt crisis, China’s market crash, and Britain’s ‘Brexit’. Furthermore, the U.S. stock market has been significantly outperformed most developed and emerging markets since the 2008 financial crisis creating little incentive to invest abroad. Retirees may be tempted to avoid international investing, but doing so could prove to be a costly mistake over the long-run.
In this article, we will look at why retirees should build international exposure into their portfolios and some tactical ways to do so.
Why Should You Invest Abroad?
Most of the world’s total market capitalization is domiciled outside of the United States, but the average investor has less than 30 percent exposure to international investments. This so-called home bias — where investors tend to over-invest in their home country — suggests that most investors miss out on the benefits of international diversification. These benefits include both higher potential returns in other countries and regions as well as lower risk through diversification.
The United States equity markets have been a mediocre performer compared to developed and emerging markets abroad over the past 20 years. Egypt has been the best performer with a 13.5 percent average annual return, but even Canada edged out the United States by 0.2 percent per year, based on each country’s respective MSCI index returns.
Investors may have missed out on these returns by investing exclusively or mostly within the United States.
In addition to improved returns, international investments help reduce risk through diversification. Many U.S. multinational stocks have a high correlation (> 0.90) with the S&P 500 index, which means they may not offset broad market declines.
These same companies have a lower (~0.80) correlation with global ex-US markets and even lower correlations with emerging markets, frontier markets, and other niche international investments. Follow these tips for international investing:
Focus on High-Quality Income
Many investors rely on fixed income or dividend stocks to finance their retirement. In the U.S., municipal bonds or blue-chip stocks are often used to generate safe and consistent income. International markets offer similar investment options with less correlation to U.S. markets, including high-yielding emerging market bonds and multinational dividend stocks with attractive yields, which aren’t dependent on the U.S. economy.
Don’t Ignore Risky Markets
Emerging market equities have a 15-year track record of outperforming the S&P 500 index despite their recent downturn. While they may be more volatile than equities in developed economies, they may have a place in a diversified portfolio where there are long-term investment needs. These markets can help diversify against loss if the U.S. economy were to decline and boost long-term risk-adjusted returns.
Many international markets are riskier than their domestic counterpart, but diversifying exposure can help mitigate that risk without compromising returns.
For example, investing exclusively in Egypt due to its higher historical performance would be extremely risky given its volatility, but gaining exposure to Egypt through a diversified emerging market exchange-traded fund (ETF) could reduce that risk without compromising the higher returns.
Ignore the News
Many investors believe international investing is risky due to the scary headlines dominating the news media. While these headlines may cause some concern, the market tends to be ahead of the curve in estimating risk and reacting to them is often too little, too late. The ‘Brexit’ is a great example of where the market initially swooned before moving higher shortly after the supposedly negative news that Britain would be leaving the European Union.
Hedge Currency Risk
The biggest international investing risk for retirees living on U.S. dollars is currency risk.
For example, a Chilean government bond paying 5 percent in local currency may lose money when the local currency is converted back to U.S. dollars and paid to the investor. The good news is that investors can hedge against these risks using futures contracts or specially-designed exchange-traded funds (ETFs) that automatically ensure currency risk is hedged.
The Bottom Line
Retirees may be tempted to pass on international investments given their perceived risk and difficulty, but doing so could prove to be a costly mistake over the long-run. These investors should focus on identifying high-quality income and diversify across all areas while being sure to hedge against currency risk and ignore the news. These actions can help significantly increase risk-adjusted returns over time.