What are “Emerging Markets”?
Emerging Markets is a developing country, think Mexico, China, South Africa, etc. That is the alternative to a developed country such as the US, Germany, Japan, etc. The category is filtered further by assuming which countries will be the next great economies. The countries therefore display the below characteristics:
Economies with higher expected growth rates.
Large economies to begin with. Due to a large population (India) or natural resource base (Saudi Arabia).
Moderate levels of GDP per capita. The next in line to become developed, which historically are the fastest growing economies. Economies extremely low in GDP per capita, are excluded, as they still lack the basic societal infrastructure to exhibit extreme growth and stable markets.
Why invest in Emerging Markets?
In theory, they provide higher returns on investments than the US stock market. This is due to higher population growth, ability to develop their economy by bringing up their middle class, and receive economic growth from improvements in education and infrastructure that developed economies already have in place. Though historically this has not been the case.
As you can see below, Emerging markets outperformed the total US stock market for only one significant period. Roughly 2003, to 2011. You can see this by how the red line (emerging markets) catches up with the blue line (US market). Therefore, the red line is growing faster than the blue line, which would be outperformance. But right after and before that, you can see a massive divergence where US stocks outperform significantly.
As always, this is no indication of future performance, but something to keep in mind when making your investment decision. From the data below and my personal opinions, I don’t believe emerging markets are as good of an investment as they are theorized to be. As such, I do not personally invest in emerging markets.
But, there is some diversification power between Emerging Markets (EEM below) and the US stock market (IVV below). The below image shows the correlation of returns between Emerging markets and the US stock market. This shows 73% of emerging market returns are tied directly to the US stock market returns. But 27% are not. Which could be helpful when constructing a portfolio.
Basically, the closer the number is to 0, the greater the diversification power of the investment. Diversification provides a smoother ride when growing your wealth.
Risks of investing in Emerging Markets
All risks associated with buying stocks. Performance is mostly tied to the growth of their local economy.
Higher risks, compared to the US markets, associated with corruption, political uncertainty, and geopolitical events.
Currency risk, which accounts for the change in value of currencies compared to one another. Let’s say the US dollar appreciates, which means it goes up in value, compared to emerging markets currencies by 5%. Well, the fund must grow at 5% just to make up for that loss of value due to currency fluctuation. Now this does go both ways but adds another layer of risk.
How to invest in Emerging Markets?
Open a brokerage account. Ex. Merrill Edge, Vanguard, Charles Schwab, etc.
Or there may be an emerging markets investment option in your 401k.
Fund the account.
If using your 401k, adjust your percentages within the plan so some money goes into the Emerging Markets fund.
Select which funds to invest in. I recommend a broad Emerging Markets ETF for beginners. This will give you exposure to many emerging markets around the globe.
Buy the selected fund. Below are some options you should consider. All give broad exposure across many countries, and have low fees.
VWO – Vanguard FTSE Emerging Markets ETF
SCHE – Schwab Emerging Markets Equity ETF
SPEM – SPDR Portfolio Emerging Markets ETF
Email me at Marlinfinancialadvisors@gmail.com if you have any questions.
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