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Charting a Course for Emerging Markets

Feb 26, 2008
Investors dissatisfied with domestic returns have been seeking greater growth in foreign markets. As noted in last week's article, the growth of emerging markets is not a short-term fad, but a long-term trend that will affect global markets for years to come. The question then, is how you can take advantage of this opportunity without losing your shirt. Read on to find out.

The returns of foreign emerging markets are truly impressive-20%-100% a year or more isn't uncommon. Who wouldn't want to earn 83% in one year like the China index FXI did? Or the 58% it did in 2007! These dramatic returns have caused some investors to throw caution to the wind. They've moved significant portions of their portfolios to these markets only to suffer devastating losses.

That's not what I want for my clients, nor do I want it to happen to you. While the returns are much higher, the risk is also much greater. Unless you have carefully planned how to control that risk then you should leave these markets to the professionals.

Here's the real question. Are you willing to endure losses of 20-50% that can last for months in order to achieve those stellar returns? Most are not. They jump into these markets only to get discouraged and sell after a big decline. The China index (FXI) is down over 30% since its peak in October of 2007. Would you still be hanging on to it?

Daily swings of 5% to 8% are not uncommon for large-cap Chinese stocks. Newer markets, like those in Vietnam, can take huge dives very quickly. Governments, along with their financial regulations, can change overnight. Growing pains are common for developing markets and those with the stomach to handle the wild ride can be richly rewarded. Clearly, investors have to match their foreign exposure to their appetite for risk.

Investing in emerging markets is not for the faint of heart. That doesn't mean that you shouldn't do it. Start small by only investing a couple of percent of your overall portfolio. Then you need to decide the method of investing that is best for you.

There are several ways you can invest in foreign and emerging markets. You can buy individual stocks on the foreign exchange. You can buy foreign companies that are listed on U.S. exchanges. There are exchange-traded funds (ETFs) for just about every country and/or region. There are mutual funds. You can buy bonds as well as stocks.

I only recommend buying stocks on a foreign exchange for advanced, sophisticated investors. This isn't as hard as it used to be thanks to online brokerage firms, but is still pretty involved. First, the markets like the Hong Kong exchange are located half-way around the world. That means their market is open while it's nighttime here. Second, you have to convert your money to the local currency prior to making a purchase.

It's much easier to buy large foreign companies that trade on U.S. exchanges. Doing so isn't any different than buying any other U.S. stock. Some of these companies trade on the pink sheets. If you go this route, beware of the daily trading volume and the spread (the difference between the bid and ask price).

Good quality mutual funds are perhaps the most popular way to invest outside the United States. There are too many choices to list here and doing your research before you invest is crucial. Some have active management, while others are more passive. Some focus on specific markets while others are more general in nature. Fees can vary widely as well.

No matter how you invest, one major risk to consider is currency risk. When the U.S. dollar is falling, foreign returns benefit. When the dollar is rising, however, foreign returns suffer. This means your return can either be wiped out or greatly boosted, depending on what the currency markets are doing.

While the superlative performance of emerging markets is long term trend, many tactical decisions will need to be made along the way. There are simply too many changes in the governments, rules and regulations and the economies themselves to just set it and forget it. Professional management can add significant value and help you take full advantage of the opportunities that are available.
About the Author
Nationally-syndicated financial columnist and Certified Financial Planner(R) Jeffrey Voudrie provides personal, in-depth money management services and advice to select private clients throughout the USA.

Read more at www.guardingyourwealth.com.
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