Question

Discuss why international diversification reduces portfolio risk.

Answer 1

International diversification helps reduce portfolio risk in the following ways:
1) When U.S stocks do not perform well, stocks from emerging markets or other
developed nations may outperform the U.S markets. Investing in international
stocks in such instances can reduce portfolio risk. Different nations have
market cycles that do not coincide with each other. An investor can capitalize on
the ups and downs of the markets in different countries. For instance, when the
U.S stocks are down, stocks in emerging countries in Latin America or China might
be on the upswing. An investor can diversify his/her portfolio by investing in these markets.
2) When an investors buys foreign stocks, the investor has to buy the stocks in
the international currency.
When the U.S dollar falls and the foreign currencies rise, the international investments that are made in foreign
currencies can help stabilize the portfolio.