How to Invest In Emerging Markets

Posted on January 10, 2014 at 9:36 AM PDT by

If you’ve been investing at all in the past 10 years, chances are you’ve heard someone say the “emerging markets” are a good investment bet.

And that’s largely true, with some caveats. Like any asset class,  you shouldn’t overdo it. It’s important to take measured investment risks.

emerging markets

First, a definition: An “emerging” market is generally understood to be a high-growth developing country. Nevertheless, emerging countries can be large. China is considered emerging, even though it’s the second-largest economy in the world. Brazil is emerging, as are India and Russia.

What these countries have in common is high growth rates, often driven by export economies and consumption. Many have young populations, so the shift to urban consumer lifestyles results in greatly increased imports and, in time, greater domestic manufacturing.

Here are some retirement investing caveats when it comes to emerging markets:

1. Growth can be uneven

Like with small-cap stocks, emerging markets have their ups and downs. It’s nearly impossible to predict which year or run of years will provide excess returns and which year will be the disaster during which investors flee for safer shores. Once you decide how much exposure to volatility you can handle, keep within those limits.

2. Risks are difficult to measure

It’s hard to predict the medium-term fortunes of even the most staid of U.S. blue-chip stocks, and here you have the advantage of timely public reporting. Emerging market companies do report results, but the interplay of regulation, market forces and competition are much harder to grasp from thousands of miles away.

3. Currency comes into play

Corporations deal with this all the time: The foreign subsidiary had an off year, but the exchange rate means more dollars once those profits are repatriated. Or, possibly, a good year is weaker thanks to currency shifts the other direction. All of this will affect your return, and predicting those outcomes is beyond even rocket scientists.

4. Political risk is greater

Emerging markets profits through the roof? A single election can change that overnight. Incoming governments can hike taxes and change policies dramatically. Domestic monetary policy is a factor as well, and broadly unknowable until it’s too late to act.

5. Markets are less liquid

The really powerful thing about investing in the major world markets is that you are not alone. Millions upon millions of individuals and institutional buyers and sellers keep prices stable during trading hours. If you invest in an emerging market, the ride can be a bit bumpier.

Bottom line: Invest in emerging markets, but do so through U.S.-based ETFs that help you limit the aforementioned risks. Make sure your exposure is in line with your long-term retirement portfolio plan.

Finally, strive to avoid “playing” countries. Instead, rebalance along the way to capture gains as they happen in a timely fashion.