Why Emerging Markets are a High-Risk High-Reward Play Right Now

Ever feel like your money in a regular savings account is just… sitting there? Maybe you're looking at your investment-portfolio" class="auto-link" target="_blank" rel="noopener">investment portfolio and thinking, "Could I be doing more?" I've definitely been there.

It's natural to want your money to work harder for you. And sometimes, that means looking beyond the usual suspects like big US stocks to find growth opportunities you might be missing.

What This Actually Means for Your Wallet

When we talk about "emerging markets," we're not talking about obscure, far-off places. We're talking about countries like China, India, Brazil, or even smaller nations that are rapidly industrializing and growing their economies. Think of it as investing in the next big thing, often before it becomes a household name.

For your wallet, this means you're potentially tapping into economies that are expanding much faster than established giants like the US or Europe. My friend Sarah put $1,000 into an emerging market ETF back in 2020. That same investment is now worth roughly $1,650, even with some ups and downs along the way.

The Basics of Emerging Market Investing

Alright, so what exactly are emerging markets? They're essentially countries that are still developing but are showing significant economic progress and have the potential for rapid growth. They're moving from agrarian or commodity-based economies toward more industrialized, service-driven ones.

These countries often have a booming young population, a growing middle class, and increasing consumer spending. That combination can fuel some serious economic activity and, hopefully, investment returns. You're betting on their future.

How It Works in Practice

Investing in emerging markets usually doesn't mean buying individual stocks in companies you've never heard of. That's a super high-risk move for most of us. Instead, people typically go for diversified funds.

You can buy an Exchange Traded Fund (ETF) or a mutual fund that holds stocks from many different emerging market companies across various countries and sectors. This spreads out your risk significantly. My cousin Mark, for example, uses an ETF that tracks companies in about 20 different emerging nations.

Here’s a quick look at why these markets are so appealing to some investors:

• Higher Growth Potential: Developing economies often have more room to grow their GDP and corporate earnings compared to mature markets. They're playing catch-up, which can mean explosive expansion.
• Diversification Benefits: Adding emerging markets to your portfolio can help spread risk beyond just your home country's economy. Their market cycles sometimes don't move in lockstep with developed markets.
• Innovation and Demographics: Many emerging economies are centers of innovation, especially in tech, and boast large, young populations. These are powerful engines for future economic growth.
• Lower Valuations: Sometimes, companies in emerging markets trade at lower price-to-earnings ratios than their developed market counterparts. This means you might be getting more growth potential for your dollar.
• Access to New Industries: You might gain exposure to industries or business models that are less prevalent or already mature in Western markets. Think about the massive digital payment adoption in places like India or China.

Getting Started with Emerging Market Investments

Okay, so you're curious and want to dip a toe in. How do you actually do it? It's simpler than you might think, but definitely requires a bit of homework. You wouldn't just throw money at any old thing, right?

Step 1: Do Your Homework on the "Why"

Before you even think about buying anything, understand why you want to invest in emerging markets. Are you looking for long-term growth? Diversification? Knowing your goal will help you pick the right kind of investment. I always tell my friends, don't invest in something just because it's "hot."

Step 2: Pick Your Investment Vehicle

For most of us, this means choosing between an Emerging Markets ETF (Exchange Traded Fund) or a mutual fund. ETFs are generally lower cost and trade like stocks throughout the day. Mutual funds are bought or sold at the end of the day's trading and might have higher fees. I personally lean towards ETFs for their flexibility and low expense ratios.

Step 3: Choose a Brokerage Account

You'll need an investment account with a brokerage firm to buy these funds. Most major brokerages like Fidelity, Vanguard, Schwab, or even newer platforms like Robinhood or M1 Finance offer access to a wide range of emerging market ETFs and mutual funds. If you already have an investment account, you're likely good to go.

Step 4: Start Small and Diversify

Don't put all your eggs in one basket, especially with something like emerging markets. Start with a small percentage of your overall portfolio, maybe 5-10%. Then, make sure the ETF or fund you choose is already diversified across many countries and industries, not just one specific nation or sector.

Step 5: Monitor and Rebalance Regularly

Once you've invested, don't just forget about it. Check in on your emerging market holdings periodically, maybe once a quarter or twice a year. If they've grown significantly and now make up a larger chunk of your portfolio than you intended, you might want to trim some back to maintain your desired allocation. This is called rebalancing, and it's a smart move.

Real Numbers: The Potential (and Risk)

Let's talk about what kind of returns we're potentially looking at. Remember, past performance doesn't guarantee future results, but it helps illustrate the upside. Historically, emerging markets have shown periods of very high growth.

For example, between 2003 and 2007, the MSCI Emerging Markets Index actually outperformed the S&P 500 significantly. You could have seen annual returns well into the double digits during that period, even over 20% some years. If you'd put in $500 a month consistently during that time, you'd have seen some impressive gains.

Consider this: Let's say you invest $200 a month into an emerging market ETF. Over 10 years, if it averages a 9% annual return (which is quite good, but achievable in strong periods for emerging markets), you'd have invested $24,000 of your own money. Your total balance could be around $38,000. That's $14,000 in pure growth.

Now, compare that to a hypothetical 7% return from a more conservative developed market fund. The same $200 a month over 10 years would give you about $34,700. That's still great, but it shows the potential for higher returns in emerging markets. Of course, that higher potential also comes with higher risk, which we'll get into.

Quick math: If you invest $300/month at an ambitious 10% (possible in emerging markets, but not guaranteed!) for 10 years, you'll have roughly $59,000. You only contributed $36,000 yourself, so that's over $23,000 in potential gains. It shows the power of compounding.

It's not all sunshine and rainbows, though. There have also been periods where emerging markets lagged developed markets for years. For instance, from 2011 to 2015, emerging markets struggled, while the US market surged. You need to have a long-term perspective and stomach for volatility.

What to Watch Out For

Investing in emerging markets isn't a "set it and forget it" strategy, at least not without understanding the bumps in the road. There are some specific things you really need to be aware of before you jump in. I learned some of these the hard way, so take my advice!

First, don't chase the hottest headlines. We often see a specific country or sector in an emerging market getting a lot of hype. Suddenly, everyone's piling into tech stocks in Vietnam, for example. That's a classic mistake. By the time it's mainstream news, much of the initial growth might already be priced in, and you're entering at the peak.

Instead of chasing fads, stick to broadly diversified emerging market funds. These funds will automatically include exposure to various countries and industries, spreading your risk. My college roommate, Dave, got burned chasing a specific sector in an emerging market a few years back. It took him a while to recover.

Second, be mindful of political and economic instability. Emerging markets, by their nature, can be more volatile than established ones. Governments can change, regulations can shift overnight, and currency values can fluctuate wildly. This isn't always a problem, but it can create uncertainty and impact your returns.

You can't predict political events, so diversification again is your best friend here. Don't put too much into any single country or even region. A global emerging market fund helps mitigate the impact if one particular country has a rough patch.

Another thing to watch for is currency risk. When you invest in an emerging market, you're essentially buying assets denominated in a foreign currency. If that country's currency weakens against your home currency (like the US dollar), it can eat into your returns even if the underlying investments performed well.

Most diversified ETFs manage some of this for you, but it's still a factor. You just need to be aware that it's part of the deal. Don't get surprised if your fund goes down even when the news says their economy is booming.

Finally, liquidity can sometimes be an issue. In smaller emerging markets, there might not be as many buyers and sellers for certain stocks. This means it could be harder to sell your investment quickly without impacting the price. Again, this is less of an issue with large, diversified ETFs but something to keep in mind if you're ever tempted to pick individual stocks.

Frequently Asked Questions

Is emerging market investing right for beginners?

Honestly, it depends on your risk tolerance and how much you've already invested. If you're just starting out, I'd recommend building a solid foundation with broad-market US or global developed market index funds first. Once you have that base, then you can consider adding a small percentage of emerging markets.

It's generally not something you want to make the entire focus of your portfolio when you're new to investing. Think of it as a growth-oriented addition, not your main course.

How much money do I need to start?

You don't need a huge sum to get started. You can buy shares of an emerging market ETF for the price of one share, which might be anywhere from $20 to $100+ depending on the fund. Some brokerages even offer fractional shares, meaning you could start with as little as $5 or $10. I'd suggest starting with maybe $100 to $500 to get a feel for it, then regularly contributing small amounts over time.

The key is consistency, not necessarily a massive initial lump sum. Even $25-$50 a month can make a difference over years.

What are the main risks?

The biggest risks are volatility and uncertainty. Emerging markets can swing wildly due to political instability, currency fluctuations, and economic policy changes that happen more frequently than in developed nations. There's also the risk of less transparent regulations and corporate governance compared to the US or Europe.

These factors can lead to bigger drawdowns in your investment compared to a typical S&P 500 fund. You need to be prepared for those downturns mentally and financially.

How does this compare to developed markets?

Developed markets, like the US, Canada, Japan, or Western Europe, are generally more stable and have mature economies. They typically offer lower growth potential but also lower volatility and risk. Think steady growth versus potentially explosive, but bumpy, growth.

Emerging markets offer the chance for higher returns because of their rapid growth, but you take on more risk in exchange. It's often a trade-off between stability and growth opportunity.

Can I lose all my money?

While it's highly unlikely you'd lose all your money if you're invested in a diversified emerging market ETF, it's certainly possible to experience significant losses. If you're buying individual stocks in emerging markets, the risk of total loss on that specific stock is much higher.

The diversification within an ETF spreads your money across many companies and countries, making a total loss of the entire fund extremely improbable. However, a 30-50% downturn over a few years isn't out of the question during tough economic times. That's why a long-term mindset is essential.

What's a good percentage of my portfolio for emerging markets?

Most financial advisors suggest keeping your emerging market exposure to a relatively small portion of your overall portfolio. For many people, anywhere from 5% to 15% is a common recommendation, especially if you're younger and have a longer investment horizon. Someone closer to retirement might choose an even smaller percentage, or none at all.

It really depends on your personal risk tolerance and financial goals. Always assess your comfort level with potential losses before allocating a significant amount.

The Bottom Line

Emerging markets definitely offer an exciting opportunity for higher returns and diversification in your investment portfolio. But you absolutely need to go in with your eyes wide open, understanding the higher risks involved. It's not a set-it-and-forget-it strategy for the faint of heart.

If you're ready for some potential volatility and have a long-term outlook, consider allocating a small portion of your investments to a diversified emerging markets ETF. Just make sure it fits your overall financial plan and risk tolerance.