Selecting Investments in a Global Market

Investors who want the broadest range of choices in investments must consider foreign stocks and bonds in addition to domestic financial assets. Many foreign securities offer investors higher risk adjusted returns than do domestic securities. In addition, the low positive or negative correlations between foreign and U.S. securities make them ideal for building a diversified portfolio.

Foreign bonds are considered riskier than domestic bonds because of the unavoidable uncertainty due to exchange rate risk and country risk. The same is true for foreign and domestic common stocks. Such investments as art, antiques, coins, and stamps require heavy liquidity risk premiums. You should divide consideration of real estate investments between your personal home, on which you do not expect as high a return
because of nonmonetary factors, and commercial real estate, which requires a much higher rate of return due to cash flow uncertainty and illiquidity.

Studies on the historical rates of return for investment alternatives (including bonds, commodities, real estate, foreign securities, and art and antiques) point toward two generalizations.

1. A positive relationship typically holds between the rate of return earned on an asset and the variability of its historical rate of    return. This is expected in a world of risk-averse investors who require higher rates of return to compensate for more uncertainty.

2. The correlation among rates of return for selected alternative investments is typically quite low, especially for U.S. and foreign stocks and bonds and between these financial assets and real assets, as represented by art, antiques, and real estate. This confirms the advantage of diversification among investments from around the world.

In addition to make many direct investments, such as stocks and bonds, we also could use investment companies that allow investors to buy investments indirectly. These can be important to investors who want to take advantage of professional management but also want instant diversification with a limited amount of funds. With $10,000, you may not be able to buy many individual stocks or bonds, but you could acquire shares in a mutual fund, which would give you a share of a diversified portfolio that might contain 100 to 150 different U.S. and international stocks or bonds.

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