Question

In recent years, investors have agreed that the market portfolio consists of more than just U.S. stocks and bonds. If you are an investor who invests in only U.S. stocks and bonds, describe the effects on risk in your portfolio:

Answer 1

In recent years, investors have agreed that the market portfolio consists of more than just U.S. stocks and bonds.

Market portfolio consists of all types of investible assets from stocks(large cap, mid cap, small cap), debentures( public debt, corporate debt), real estate, gold, ETFs, Mutual Funds etc. in a weighted proportion of their total vaue in the entire asset's universe and thus gives return which is equal to market's rate of return.

If one invests in only U.S. stocks and bonds, though it might be easy and safe to invest in a geography one is well aware of and can certainly relate to but it simultaneously might have varied kinds of risk on the portfolio.
Some of them are listed below:

1. Concentration Risk:
Conentration risk refers to a risk of deploying high proportion or value of portfolio large enough to be at risk if the concerned geography faces any risk - natural calamity, political tensions, social unrest etc. Thus diversifying helps in coping up with the volatility of a single financial makrket of one particular region.
For Example: If COVID would have been only restricted to China as a geography (hypothetically), and investor's portfolio was heavily inclined towards Chinese stocks, it would have had a severe impact on the portfolio's value.

2. Interest Rate Risk:   
If an investor only invests US Stocks and bonds, he might not be able to take advantage of the higher interest rates offered by the developing economies. Also, investing in a single country might lead to deterioration of asset quality or increase in credit risk if the credit rating of the soveriegn bonds fall for that particular economy. The reasons can be numerous - inability to pay off soverign debt, increase in fiscal deficit, rise in inflation, increase in NPAs(Non Performing Assets) of the banking system, to mention a few.
For Eg: An investor might earn ~1.5-2% in US markets whereas can earn multiple times if he invests in the developing markets like India - be it bonds or equities.

3. Correlation Effects :
Geographical diversificatiion of the stocks helps an investor or portfolio manager to take an advantage of not so correltaed financial markets across the world.
For Eg: If say, Asian stocks are going down due to any reason, one might allocate resources to say US stocks which might have low coorelation with asian economies

4. Currency Risk :
Investing in multiple currencies or stocks of various country's financial markets can help your portfolio tide over depreciation of one single currency buy reducing the currency risk or exchange rate risk. Depeeciation of a currency can negatively affect the value of investments and also the return on investments - Dividend or interest rate payments  

One should not concentrate his investments in one single geography is well explained by Warren Buffet as well through his saying - " Do not put all the eggs in one basket"   

In the similar fashion, a prudent investor would diversify his investment portfolio not only geographically, but also
- Sector wise,
- Asset wise,
- Income generating or wealth preservation wise
- Time Horizon wise - short term, Medium or long term
- Goal Wise etc.