Emerging Markets: Dipping into International Waters

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With U.S. and European markets battered by economic crises, many investors are on the hunt for more promising places to invest. And the world's emerging markets – countries undergoing rapid economic growth due to industrialization – have thrown out the welcome mat.

According to the University of Iowa Center for International Finance and Development, the five biggest emerging markets are China, India, Indonesia, Brazil and Russia. Also considered emerging markets are Mexico, Argentina, South Africa, Poland, Turkey, and South Korea.

The lure of double-digit returns – the MSCI Emerging Markets index climbed 74.5% in 2009 – can be difficult to ignore. However, the same MSCI Emerging Markets index fell a gut-wrenching 54.5% in 2008.

While emerging countries are primed for growth thanks to rising gross domestic product and increasing disposable income, their markets are much riskier and more volatile than developed nations. Emerging market cycles tend to be much more frequent and dramatic than those of developed markets. There may be too much or too little government control, their population may be large (potentially a significant source of new consumers) but poor, and there may be significant shifts in currency value. They may also have differing financial, legal and accounting rules than those of mature markets.

Are You Ready?

The ups and downs of emerging markets are not for the faint of heart, but allocating a portion of your portfolio to developing nations may help diversify your holdings. Your 403(b) or 457 plan vendors may have emerging markets mutual funds available to you. If not, you can investigate them on your own. However, before you invest in emerging markets, consider the following:

Wade in slowly. If you have a long time horizon and the stomach for sharp swings in returns, you may be able to ride out the volatility of emerging markets. Emerging markets represent about 24% of the world markets by market capitalization, or the total value of outstanding shares, according to Bloomberg (past performance is not an indication of future results).

Many experts suggest keeping just 10% to 25% of your total portfolio invested abroad, and only a portion of that amount in emerging markets.

Know your options. There are several ways to invest in foreign lands, each with its own pros and cons. Investing in domestic companies with significant business in emerging markets may help you reap the rewards with a bit less risk than purchasing individual foreign stocks or an emerging market mutual fund. Also, if you are interested in emerging markets but your 403(b) or 457 plan vendor does not offer one as an investment option, you could consider investing in such a fund in a personal taxable account or in an individual retirement account (IRA).

Annual Returns of MSCI Emerging Markets Index and the S&P 500, 2005-2009

Market indexes are used to track the performance of specific market segments. For example, as of May 2010, the MSCI Emerging Markets Index tracks the performance of 21 emerging market countries. The S&P 500 tracks the performance of 500 widely held stocks and is considered a broad measure of the U.S. stock market.

403(b) and 457 plan investors can use market indexes as benchmarks against the performance of their own investments. For example, if you have a large-cap domestic mutual fund, you may want to consider its performance as compared to the performance of the S&P 500 over the same period.

  MSCI Emerging Markets Index* S&P 500**
2005 30.3% 4.9%
2006 29.2% 15.8%
2007 36.5% 5.5%
2008 -54.5% -37.0%
2009 74.5% 26.5%

* Source: www.mscibarra.com. Past performance is not an indication of future results.
** Source: www.standardandpoors.com. Past performance is not an indication of future results.