Diversification when investing is arguably more important as a risk management strategy for Americans living in Europe than if you live in the States. This is because there are additional factors to consider as an expat investor, including which country to invest in, and dealing with two currencies. However, living overseas also provides diversification opportunities, with access to investments in both countries.
In this article, we’ll explore why diversification matters, asset classes to consider, and how to build a well-rounded investment portfolio as an American in Europe that can weather the complexities of international living.
Why diversification matters
Diversification is a fundamental principle of investment strategy, and its importance cannot be overstated. Essentially, it involves spreading your investments across different asset classes, regions, and sectors to reduce risk. It works as if one investment, asset class, region or sector underperforms, others compensate, helping to balance your overall portfolio.
For American expats living in Europe, diversification serves several purposes:
Risk mitigation
Diversifying your investments across various assets can help protect your wealth from significant losses in any single investment. This is particularly important when navigating the financial landscapes of both the United States and Europe.
Currency risk management
American investors living in Europe have to deal with multiple currencies. Diversifying your investments can help you manage currency risk (being sthe risk of investment values being affected by a weakening of the value of the currency it’s denominated in) by holding assets in different denominations.
Market volatility
Different asset classes behave differently in various market conditions. A diversified portfolio can help you navigate market volatility and achieve more stable returns over time.
Lifestyle flexibility
As an expat, your financial needs and goals may differ from those of your peers in the United States. Diversification allows you to tailor your investments to your unique circumstances.
Asset classes to consider
When building a diversified investment portfolio as an American expat in Europe, it’s essential to invest in various asset classes, which represent different categories or types of investments. The idea is that factors adversely affecting one asset class could potentially favor another. These might include:
Equities
Investing in both US and Spanish stocks can provide geographical diversification. You can also explore international stocks for further diversification.
Fixed income
Bonds are debt securities that pay periodic interest and return the principal at maturity. They are generally less volatile than stocks and can provide income stability. US and Spanish government bonds, corporate bonds, and international bonds can all be part of a diversified bond portfolio.
Real estate
Real estate investments, such as property or real estate investment trusts (REITs), can offer diversification by asset class.
Exchange-traded funds (ETFs)
These are tradeable bundles of securities that track an index, commodity, or sector.
Commodities
Essential raw materials required for producing various goods and services.
Cash and cash equivalents
While not an investment per se, holding some cash and cash equivalents provides liquidity and flexibility. Money market funds, certificates of deposit (CDs), and high-yield savings accounts can serve this purpose.
Alternative investments
Consider adding alternative assets like hedge funds, or private equity to your portfolio. These assets can offer diversification and unique risk-return profiles.
Precious metals
Investing in precious metals like gold and silver can act as a hedge against inflation and currency fluctuations.
Market capitalizations: Large vs. small
When considering stock investment opportunities, one diversification strategy focusses on market capitalization, which broadly categorizes companies into “Large” and “Small” cap stocks.
Large-cap stocks
These are typically well-established, prominent companies with extensive market presence. Large-cap companies often have market capitalizations exceeding $10 billion. They tend to be industry leaders, known for stability and established track records. Investors in large-cap stocks often seek steady returns and lower volatility.
Small-cap stocks
In contrast, small-cap stocks represent smaller companies with market capitalizations generally ranging from $300 million to $2 billion. These firms are often in their growth phase, offering substantial potential for capital appreciation. Small-cap stocks are known for their higher volatility and may carry more risk, but they can also provide exciting growth opportunities for investors willing to accept greater fluctuations.
The choice between large-cap and small-cap stocks depends on your investment objectives and risk tolerance. Diversifying across both can help balance your portfolio and achieve a mix of stability and growth potential.
Risk profile and balancing your portfolio
Every investor has a unique risk tolerance and financial goals, and understanding your risk profile is fundamental to building a diversified investment portfolio that aligns with your individual circumstances. Your risk profile will be determined by your financial planning goals, time horizons before you want to sell or draw on your investments, and personal preferences. You should discuss and establish your financial planning and investment goals with an expat-specialist advisor before deciding what types of assets to invest in and how much risk and diversification would be appropriate for your portfolio.
Final Thoughts
Diversification is a cornerstone of successful investing for American expats in Europe. It can help mitigate market risk, navigate currency fluctuations, and achieve your financial goals. Building a diversified portfolio requires careful planning and consideration of various asset classes. By taking a thoughtful and strategic approach to diversification, you can create a robust investment strategy that aligns with your unique circumstances and helps you thrive as an American living in Europe.
If you have any questions about financial planning or investing as an American living in Europe, get in touch.
This article is for informational purposes only; it is not intended to offer advice or guidance on legal, tax, or investment matters. Such advice can be given only with full understanding of a person’s specific situation.