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Post: Brett Arends’s ROI: Are emerging markets too ‘risky’ for retirees?

Emerging markets are in the news again, for good reasons and bad.

For the good, look no further than the winter Olympics in Beijing. And reflect that China’s economy has tripled in size since it hosted the summer games, just 14 years ago. China, just an undeveloped rising star a generation ago, is now the world’s biggest economy.

On the other hand, for the bad, look no further than Russia’s threatening moves against Ukraine. Or look at the economic crisis in Turkey. Or, for that matter, look at China—where the cases of tennis star Peng Shuai, the religious Uyghur minority, and the longstanding threat against Taiwan all remind us that the country remains unfree.

Emerging markets, which include such economies as China, Russia, India, Brazil, South Africa and the like—have a racy reputation among investors. They are seen as volatile and “high risk.” As we get older, we tend to dial down the risk in our portfolios generally. And that’s especially true once we’ve retired, when most people look for financial stability and income.

So it may be tempting to think that such emerging markets have no place in your portfolio once you’ve retired. Especially amid the current uncertainty. And especially after recent performance: Emerging market indexes performed poorly again last year, even while the U.S. and many developed markets, for example in Europe, did well.

But you might want to think again.

Many financial advisers say investors should keep emerging markets in their portfolios even after retirement, despite any risks, for a very simple reason: diversification.

“Any equity investor should have EM (emerging markets) in their portfolio,” says Kenneth Waltzer, managing director of KCS Wealth Advisory in Los Angeles. “Diversification means investing globally, as this both reduces risk and can increase return. For EM stocks in particular, they tend to follow cycles that can be opposite the US.”

If older investors want to dial down the risk in their portfolio, he says, they should look at cutting their overall exposure to stocks in general, not simply at cutting their exposure to emerging markets. “An older investor might not have less EM in their equity allocation than a younger investor, but they are likely to have less equity exposure overall,” he says.

David Shotwell, a financial adviser at Shotwell Rutter Baer Financial Planners in Lansing, Mich., agrees. “Emerging markets offer diversification from U.S. and developed domestic markets as they do not move (in) lockstep with those markets,” he says. “We limit emerging market exposure to 10% of our overall stock exposure. So older investors have exposure as well. For example, a 50% stock portfolio would have 5% in emerging markets.”

The key, he says, is sticking with the portfolio, and not getting thrown off track by headlines or short-term volatility. “By the time headlines like Ukraine are printed the markets have already moved,” he says. “Stay disciplined for the long run.”

Emerging markets have done poorly for investors over the past decade, while U.S. stocks have boomed. But in the first decade of the millennium it was the other way around. Emerging markets tripled your money, while U.S. stocks overall earned almost nothing.

Not everyone is a fan, though. Financial adviser Ian Weinberg, chief executive of Family Wealth & Pension Management in Woodbury, N.Y., questions whether emerging markets add much if anything to a stock portfolio. They’ve become increasingly correlated with U.S. and other developed markets, he argues. Furthermore, they seem to “lose more than U.S. stocks in down markets, and have lower returns than the U.S. in up markets,” he says. He thinks older investors in particular can do better without the added risks.

Traditionally, those in retirement were usually advised to dial down their exposure to the stock market and instead hold many or most of their assets in lower-risk bonds instead. Times have changed. Bonds don’t pay the interest rates they used to: A bond portfolio today won’t even keep up with inflation, let alone grow wealth. Meanwhile retirees have to budget to live longer than their parents or grandparents could expect. That means they need to make their portfolios last longer after retirement, and that means they have to keep more exposure to stocks.

The general recommendation these days is to lower your stock exposure in the very early years after you retire, and then raise it as you get older.

Investors can get at least some exposure to emerging markets these days through many international or world stock funds. For example emerging markets make up about 10% of the Vanguard Total World Stock ETF
in line with their weightings in the global indexes. An investor in that fund gets as much exposure to emerging markets as they do to the stock markets of London and Tokyo put together. Or individuals can choose their own exposure through a fund that directly targets emerging markets. Vanguard FTE Emerging Markets
Schwab Emerging Markets Equity
iShares Core MSCI Emerging Markets ETF
and SPDR Portfolio Emerging Markets

all charge low expenses of around 0.1% of your money per year.

The biggest concern for investors today may be that a third of an entire emerging markets index may now accounted for by China, a one-party state controlled by a dictatorship, while another 20% accounted for by Taiwan. That potentially puts half of the index at risk of turmoil if the tension over Taiwan turns hot. China refuses to recognize independent Taiwan, and has made no secret of its desire to take it over, one way or another.

There are ways to invest in emerging markets while reducing that risk. For example, some emerging markets funds simply exclude China (though they still include Taiwan): These include Columbia Threadneedle’s Columbia EM Core ex-China ETF

and iShares’ MSCI Emerging Markets ex China ETF
You can also pick funds that invest specifically in individual emerging markets countries or regions. But this is beyond the level of interest of most retirees.

Howard Erman of Erman Financial Advisory in Seal Beach, Calif., points out that war between China and Taiwan may never happen anyway (the same, to be sure, is also true of Russia and Ukraine). “As my grandmother used to say, “don’t worry twice,” he says. “We’ll see what happens.”

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