Retirees who diversify globally protect themselves from investing with too much home bias.
If you are saving for a future retirement, your goal is probably to grow your capital. If you only focus on higher returns, though, you may take risks you cannot afford. Markets can be volatile. Diversifying globally may be a good way to lower volatility and smooth out returns. And if you’re retired, and if you’ve chosen to have equity exposure (stocks) in your accounts, you should certainly talk to your advisor about global diversification.
Investment portfolio risk can be reduced by investing in a mix of non-correlated assets. When one asset is moving up while another is moving down, this negative correlation can counterbalance risk. For instance, if your oil Exchange Traded Fund (ETF) has tumbled 50 percent because of decreasing oil prices, maybe you have a rising airline ETF to offset the loss. Airlines benefit when fuel is cheap. Adding global equities to a domestic portfolio is another example of non-correlated assets, since they diversify exposure away from the domestic market. Global investments can introduce non-correlated countries, industries, companies, and currencies.
An increasingly correlated global market
Do global stocks truly provide diversification opportunities?
Globally, equity indexes are becoming increasingly more correlated, meaning their prices move in the same direction more than they did in the past. Typically, the stock allocation of retirement portfolios is comprised of large companies which have growing exposure to the global marketplace. Today, companies on the S&P 500 gain between 40% and 50% of their revenues from the global market.
The rollercoaster in technology stocks reveals the risk of a non-diversified U.S. portfolio, as many U.S. stock indexes have a high exposure to the FANGs (Facebook, Apple, Netflix, and Google). Global stock indexes can have different sector weightings than domestic stock indexes. For example, the S&P 500 has a 23% weighting in technology stocks whereas the S&P 700 global index (ex-USA) has a 9% technology weighting.
The Retirement Planning Book makes suggestions on how to build a diversified retirement portfolio. Click here for a free download.
Douglas Goldstein, CFP®, is the Director of Profile Investment Service, Ltd., which specializes in helping people who live in Israel with their US dollar assets and American investment and retirement accounts. He helps olim meet their financial goals through asset allocation, financial planning, and using money managers.
Published January 1, 2018.