Tuesday, September 28, 2010

Portfolio Diversification Strategies: Don’t Let One Country Dominate Your Investment Portfolio

The 2006 Winter Olympic Games in Torino, Italy may not have quite the suspense and viewer appeal of some past Olympics. But one thing they share in common with all Olympic games: patriotism – unbridled fervor for one’s home country.

I can still remember the chants of “USA! USA!” ringing in my ears as I watched the U.S.’s amateur hockey team upset the “unbeatable” hockey juggernaut from the USSR.

Such patriotic zeal can be fun – even exhilarating – when cheering on countrymen and women in athletic events. But many people unknowingly carry that same patriotic bent into their investing portfolio. And that can result in missing out on portfolio diversification strategies that include some the world’s strongest – and most profitable – markets.

Investing Outside the Good Old USA

Many portfolios carry only U.S.-based stocks and indexes. And this is understandable. Those are the investments that we understand best. But we ignore the rest of the world at our own peril when it comes to diversifying our portfolio.

The U.S. markets are superlative in many ways – the biggest, the busiest and among the most transparent in the world. But when it comes to performance, the U.S. markets have been laggards, not leaders. Take a look at the chart below that compares the relative performance of stocks representing different companies:
In the last 12 months, the S&P 500 Index (a proxy for the U.S. stock markets) was up about 6%. After monster growth in 2003, the China Fund (NYSE: CHN) is only up 3% for the last 12 months.

But while China and U.S. stocks have been experiencing low growth, other markets have been booming. Germany, Japan and Canada are up between 23% and 38% percent for the most recent 12 months. During the same period, Brazil and India have been up 87% and 90% respectively!

Though not shown in the relative performance chart above, a little extra research reveals that of the seven countries represented above, three of them have exceeded their year-2000 highs (Canada by a little, and India and Brazil by a lot!).

Portfolio Diversification Strategies and Ancient Eastern Philosophy…

“When Testing the Depth Of the Water, Don’t Use Both Feet…”

The opportunities that spring up every year in some new foreign market might make you want to toss your whole portfolio into foreign markets. But bear in mind that these markets are very volatile. And they do go down as well as up. For example:

    * In the first five months of 2004, the China Fund lost 50% of its value.
    * In 13 months spanning 2001 and 2002, the Canada Index lost 60% of its value.
    * From March of 2000 to October of 2003, the German index dropped 73%.

Almost every portfolio could benefit from some geographic diversification strategies. But putting too much weight in country-based funds, indexes or iShares can also introduce more volatility than you’d like to your portfolio.

Two Prudent Diversification Strategies for Your Portfolio

As much as possible, you might want to use the following two diversification strategies when broadening your portfoli

    * Spread your risk geographically. Don’t just invest in countries from Asia Pacific or in European countries, or South American or North American countries. Try to add something from all the major economic regions. A lower volatility alternative might be to use regional funds or indexes that spread their investments across a whole region.
    * Diversify among momentum- and value-based countries. India and Brazil have been on strong upward moves for more than two years. But only picking countries that have had long uptrends sets you up for getting in at or near the top. Momentum plays are very useful and should be part of a diversified strategy. But they should be balanced by a couple of value plays such as investing in China, which has had a strong pullback during all of 2005.

Conclusion: Minimize risk by giving yourself some geographic diversity in your portfolio strategies.

Great trading,

D.R.

Today’s Trader’s U Tips & Tricks

    * If you like momentum plays like the India Fund and the Brazil Index have been over the last couple of years, you have to take a look at Alex Green’s Momentum Alert trading service. Alex is a sharp analyst whom I have known for several years. I personally looked at almost every one of his picks for 2005, and I know he was bringing big positive returns for his subscribers. Learn more about the Momentum Alert and catch a risk-free look at his latest newsletter here.
    * If you haven’t taken advantage of Investment U’s free reports, now is the time to check them out. One worth some extra attention is: Stock Market Investment Advice: The 2 Most Profitable Secrets of the World’s Greatest Investors. You’ll get the two secrets shared by more than 99% of the world’s best investors – the key to letting you squeeze every cent of profit from your winners, and get out with your profits intact.


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