It is known that stock market investing in general is risky; therefore, it is recommend holding a well-diversified portfolio to reduce risk. Many investors think diversifying their equity portfolio means buying large- and small-cap stocks; however, they might want to broaden their investing outlook, by looking over the horizon and investing internationally. So, why invest outside the U.S.? After all, U.S. markets are stable and have shown historically strong returns over the long term.

The financial realm consists of two types of markets: developed markets and emerging markets. Developed markets are those that met the criteria to be a considered developed. Some criteria that consider a country/market to be developed are: income per capita, high gross domestic product (GDP), level of industrialization, and Human Development Index. Economic criteria are significant in determining whether or not a country has a developed market, but it is not the only criteria.

Nowadays, international investing is not a new concept. Although we all know that risk is related in any single investment, it is actually special when it comes to international investing. According to the SEC, there are several categories of international investment’s risk, such as, changes in currency exchange rate, dramatic changes in market value, political, economic, and social events, lack of liquidity, less information, reliance on foreign legal remedies, and different market operations.

Professor Harry M. Markowitz said, "a good portfolio is more than a long list of securities. It is a balanced unity which similarly offers the investor chance and protection below a variety of possible future developments. The investor should therefore aim at an integrated portfolio which takes his individual requirements into account."1 Professor Markowitz won the Nobel Prize in 1990 for his research in the field of economic portfolio theory. His Portfolio Theory is based on empirical sizes, which analyze the connection between risk and return.

Investing outside the United States does have it benefits for investors who want to diversify their risk. Investing in foreign markets can bring high risk and reward but in turn, expands an individuals portfolio for more opportunities in an international market. Investing outside of the home country can bring diversification benefits and make a major impact on the efficient frontier curve.

International diversification is investing in nations where their economic phases are not directly correlated with the home nation. The purpose of the international diversification is mainly to reduce risk. More specifically, it is to reduce systematic risk. Systematic risk is risk that cannot be lessened through local diversification. However this systematic risk in the home nation may not be systematic in another nation, therefore it is possible to reduce this risk.

The Benefits and Pitfalls of International Diversification

International diversification happens between one country to another. It is a very complicated term to understand. I think that the easiest way to understand how it works is by think of each country as an asset. Different countries have different economic conditions, such as industrial production, inflation rate, government and monetary interventions, etc.