A few years ago, the conventional wisdom was that investors should buy emerging market stocks. After all, some said, the demographic future of the world is found in young countries.
Emerging nations would grow into developed ones, and their relatively young citizens would become property owners and productive workers. Buy in and stay in was the argument.
Then things went south. In some cases, way south. Political disruption, falling oil prices, you name it. A lot of people began to regret the risk they took on countries such as Brazil and Russia, to name just two.
Guess what? The pundits are back and they say it’s time to head abroad, once again.
So where they wrong before? Right? How can the prudent, long-term investor make sense of the risk inherent in foreign stocks, and especially emerging market stocks?
Here are a few rules of thumb retirement investors need to consider when looking at emerging market stocks:
1. Do I need this money in the next five years?
You probably shouldn’t buy any stock with the idea of selling it within five years. Trading is a loser’s game, fraught with timing risk.
The best way to own stock is with an eye toward letting it run its course over more than a few years, and the longer the better. If you need cash in 12 or 24 months for some reason, don’t invest it in stocks on the expectation of stocks going only up.
2. Do I have other investments with similar risk characteristics?
Emerging market stocks are more volatile than most other investments. They will move up and down in price more quickly than, say, large-cap U.S. stocks.
If you already own a lot of volatile small-cap stocks, adding emerging market stocks to the mix will increase the volatility of your portfolio. Perhaps that’s not a problem for you, but it might be.
3. Can I ignore the “news” for long periods?
You can find a pundit somewhere who agrees with your personal conclusions on investing. Finance experts call this “confirmation bias” — the belief that you are right soon leads you to seek evidence of your own opinions.
The long-term investor is better served by simply ignoring the headlines and especially ignoring the public opinions of professional investors. You are not their client, and their scattershot viewpoints are likely to do you more harm then good.
4. Are my domestic alternatives any different?
You’ve probably heard the argument that owning U.S. stocks is the same as owning foreign stocks, since big global food and drug companies earn so much money abroad.
While generally true, it’s unlikely that true emerging market earnings are a big piece of that pie. Meanwhile, stocks in developed foreign countries are not the same as emerging markets stocks at all.
Rather, developed foreign countries are more like the United States than not — home to big global names of their own.
5. What is my actual time horizon?
This is a biggie. If you are not planning to retire for decades, the volatility of emerging market stocks is much more friend than enemy. Rebalancing a portfolio will allow you to buy into slower periods while emerging stocks are cheaper.
When emerging stocks peak, you get to take money off the table to reinvest in other parts of your portfolio. Steady rebalancing means no marketing timing is needed.
If you expect to retire in less than five years, first consider how much volatility you can stand. Consider, too, that some portion of your retirement savings needs to grow for the years to come, should you enjoy a longer retirement than most.