Building an investment portfolio is a balancing act. The right allocations will expand your portfolio and keep you safe in the event of a crisis that affects particular markets. Key to building your portfolio is diversification across many countries and types of investments -- equities, bonds, currencies, real estate and commodities.
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In this interview, Robert Brown, Ph.D., professor at Bellarmine University in Louisville, Ky., discusses the value of investing internationally, general guidelines for building your portfolio and where the European debt crisis fits into the average Joe's investment decisions here in the U.S.
What are the pros and cons of including international investments in an investor's portfolio?
Your portfolio should be well-balanced. One that is balanced only in terms of one country is not really balanced. Focusing on only one country is equivalent to buying only one stock. The economy or price may go up or down. Only by averaging across many countries and stocks can a portfolio be diversified.
As background, this theory is usually referred to as "modern portfolio theory" and was developed by Harry Markowitz, who developed it in 1952. He later won a Nobel Prize for it. It is a theory of investment that attempts to maximize or minimize a portfolio's expected return for a designated amount of risk.
What percentage of an individual investor's portfolio should be devoted to international investments?
In the last 10 years, most supporters of the modern portfolio theory have generally kept their direct international exposure in an equity portfolio between 10% and 20%. As a result of the current international financial crisis, many investors are moving toward the upper end of this range, if not higher. The usual arguments in favor of increasing the amount are improved financial information, more transparent accounting practices, increased globalization, and increased speculation on emerging economies and international markets outpacing the growth of the United States.
Should investors limit their international investments to equities and bonds, or should they include currencies and international real estate?
Diversification means holding a wide range of assets. This means not just equities and bonds, but currencies, real estate and even commodities.
Should individual investors view the European debt crisis as it pertains to building a properly diversified portfolio?
In my personal opinion, Greece should -- and probably will -- leave the euro. If it does, it will adopt a new currency that will depreciate against the current euro. This means the value of Greek assets will fall. It's probably not a good idea to buy something now that will decline in value. On the other hand, if Greece does leave the euro, the euro will appreciate against the new Greek currency and the dollar. This means euros and euro-based assets would increase in value.
Special thanks to Robert Brown, Ph.D., professor in the Economics and Finance Department at Bellarmine University of Louisville, Ky., for sharing his insights. Greg McBride, CFA, senior financial analyst for Bankrate.com, prepared the questions for this interview.