What are Emerging Markets?
It is the name usually given to countries that have undertaken a course of action in order of establishing a more mature marketplace.
These countries don’t have today the economic strength of a developed country (U.S., U.K., Canada, Germany, etc.), but probably they’ll have in the near future.
Here are the countries included in the MSCI Emerging Markets index:
- Czech Republic
- Saudi Arabia
- South Africa
- United Arab Emirates
Why you should invest in Emerging Markets.
For many investors, Emerging Markets countries are very attractive.
Most of these countries have incredibly fast-growing economies, although today they are still not at the same level as developed countries in Europe, Japan, or North America.
Their economies have a lot more growth potential in comparison to the U.S. or any other fully developed country.
If you decide to put your money and invest in emerging market stocks you could have higher investment returns, but much more risk.
Emerging Markets Stocks usually have cheaper valuations compared to developed countries stocks.
However, it’s almost impossible to predict which countries will perform best in the future.
Here is a chart of the annual returns of different emerging market countries since 2001 ( source: https://www.lazardassetmanagement.com)
As you can easily see, if you decide to invest in an emerging market you have to deal with a big problem, high volatility, but you should not be scared of it.
As prof. Galloway says in his “Algebra of Wealth”, Diversification is your Kevlar.
So if you want an easy solution to the high volatility problem you may choose to implement a good diversification in your investment and buy an index fund that holds stocks from all emerging markets countries, avoiding the risk to pick single stocks.
Do I need to invest in Emerging Markets?
So what is the best option to grow your wealth: Invest in Emerging Markets or just buy and hold a broad U.S. index fund (VTSAX or VTI)?
If you analyze the historical returns of the U.S. and emerging market stocks, charts show that they’re positively correlated.
They tend to have positive and negative returns at the same time.
Check out the following chart that shows 2 ETFs, one following the SP500 (U.S.), the other the MSCI Emerging Markets Index. (source Justetf.com).
Usually, when U.S. stocks are up, Emerging Market stocks tend to be up too.
What differs is “how much” they’re up.
In the last 25 years, U.S. stocks have delivered about 10.0% annual returns.
Emerging market stocks have delivered only about 6% annual returns.
- During the late 1990s, U.S. stocks outperformed Emerging Markets Stocks.
- From 2001 to 2010 Emerging Markets stocks outperformed the U.S. stocks.
- In the 2010s U.S. stocks outperformed the Emerging Markets Stocks.
You simply cannot predict the future.
So, in my opinion, the best option is to just hold a diversified portfolio of both Emerging Market and U.S. stocks.
The simplest solution is to hold only one total world index fund, e.g. VT – Vanguard Total Word Index fund or VWCE if you are based in Europe.
This could dramatically lower volatility and reduce risks, and have all the benefits of a globally diversified portfolio.
Remember: Diversification is your Kevlar.