A quick look at investing overseasA quick look at investing overseas

But why invest some of your investment portfolio overseas? And if you are going to invest overseas, what’s the difference between Australia and the USA, or Europe and China? Let’s have a go answering these questions, and work through some of the upsides and risks of different approaches to investing overseas.

Why invest overseas?

As a starting point, we think it’s a really good idea to invest in New Zealand companies.  But we also think it’s a good idea to be diversified. So even if you’re a keen patriot, you still might want to have at least some of your portfolio in overseas investments. 

This is one of the many dimensions of diversification. It’s not uncommon for economic booms or busts to hit different countries with different levels of intensity, so investing in different countries can help you get a piece of lots of different booms, while also reducing the impact of any one bust. 

So what are the upsides and risks of investing in different overseas economies?

The big, developed economies

A developed economy is an economy where most of the basics are taken care of. Laws and contracts are enforced, so people can open businesses with more certainty. Important infrastructure like electricity is in place, and it’s reliable—when you flick the light switch, the lights go on, every time. People are generally well educated, so if you want to hire someone, you can rely on them having basic skills like reading and writing. 

On top of this, some of the developed economies are really large. You’ll recognise them—they include economies like the USA, Japan, Germany. They have lots of people, and they produce really valuable goods and services that they sell to the whole world. 

For example, Toyota is based in Japan. Toyota factories are all over the place, but whenever a car rolls off the line and gets sold, the profits flow back to Japan. Same goes for iPhones (USA) and even Best Foods Mayonnaise (manufactured by UniLever, a British/Dutch company).

The benefit of investing in these massive developed economies is that you get a piece of the richest companies in the world. What’s more, the big players in these economies sell things all over the world. This helps insulate them from local economic issues because there’s money coming in from all over the place. 

The smaller developed economies

There are just a few big developed economies in the world. There are also heaps of smaller developed economies. These are economies that have the same features as the larger ones (good infrastructure, reliable laws, educated people), but they don’t have the giant numbers of people that the big economies do, and they’re not as rich. 

Sound familiar? It should! You live in one of the smaller developed economies! New Zealand is a perfect example. Finland, Denmark and Ireland are also good examples. 

Some smaller developed economies are export-driven. This means they make a good chunk of their total money by selling stuff to other economies. 

For example, medium-sized Australia exports lots of natural resources like gold, iron and coal. These things are valuable, but they also cost a lot to get in the first place. What’s more, the end product is less valuable. Imagine how much more a truck full of iPhones would cost compared to a truck full of iron!

The emerging economies

Finally, there’s one more big group of overseas investments available: the emerging economies. These are economies that are still developing. They’re building infrastructure and educating their citizens, and they’re starting to sell really valuable stuff to the world. Examples of these include China, India, Russia, and Brazil. 

The big advantage of investing in these economies is that they can be more affordable than investing in developed economies. 

That bargain comes with some risks though. Emerging economies have lots of potential. If China, for example, is able to become as developed as the USA, that is potentially more than a billion people, all contributing to a hugely valuable whole. 

The risk is that building infrastructure and educating citizens is hard, expensive and takes ages. And it’s not a sure thing, either. Some economies never quite manage to emerge, which means the companies in those economies don’t have the same ability to create value that companies in developed economies have. 

But the upside is that investing in an emerging economy is potentially getting on the ground floor of huge growth. Take a look at the US S&P 500 over several decades:

Source

The value on the left is too small to see, but it’s around $20. So if you’d invested $100 in 1950 when the USA was starting to really emerge, it would be worth about $15,000 today! That’s the benefit of getting in early for an emerging economy—but that benefit comes with risk too, because some economies take ages to properly emerge, and some never emerge at all. 

Wrap it up

Investing overseas is a great way to diversify your portfolio across a geographic dimension. But every economy has its own little quirks, specific upsides and risks, and different ways of reacting to different scenarios. As always, you should do your research, make sure you’re diversified, then follow the strategy that best suits your goals.