What is Geographical Diversification

Geographical diversification is the practice of diversifying an investment portfolio across different geographic regions so as to reduce the overall risk and improve returns on the portfolio. The term also refers to the strategy employed by large companies of locating their operations in different regions or countries in order to reduce business and operational risks.

BREAKING DOWN Geographical Diversification

Much like diversification in general, geographical diversification is based on the premise that financial markets in different parts of the world may not be highly correlated with one another. For example, if the US and European stock markets are declining because their economies are in a recession, an investor may choose to allocate part of his portfolio to emerging economies with higher growth rates such as China and India.

Most large multinational corporations also have a high degree of geographic diversification. This enables them to reduce expenses by locating plants in low-cost regions and also lowers the effect of currency volatility on their financial statements. In addition, geographic diversification may have a positive impact on a corporation's revenues, since high-growth regions may offset the effects of lower-growth regions.

Pros and Cons of Geographical Diversification

Diversifying a portfolio of investments across different geographic regions can help investors avoid the peaks and valleys of a single economic region. This type of globally-diversified portfolio can help reduce volatility over a less-diversified portfolio in the long run. Exchange-traded funds (ETFs) and mutual funds have made investing globally easier than ever before.

There are some investors and economists who would argue that since everything in our global economy is already so interconnected, any international investments might be redundant to domestic ones. It's also important to consider that many of the largest companies in the world are already set up as multinationals.

Faster-growing international economies and markets may also experience heightened levels of political riskcurrency risk, and market risks compared to more developed markets.

International currency exchange rates are always on the move. Sometimes, one currency may be strong, and other times it may be weak. Leveraging these movements to reallocate from a position of strength may benefit the investor. Investing in multiple currencies can also provide an additional layer of risk reduction.

Domestic markets have become very competitive with many businesses offering similar services. Foreign markets, however, may offer a less competitive and sometimes a larger potential market. A business may sell more wearable devices in one Asian country than in the entire U.S. market, as an example.