What percentage of my money should I invest outside my country?

Question

I live in India, and invest in both Indian and international equity mutual funds[1]. What percentage of my portfolio should I invest outside India?

I thought that since India's GDP is some 3% of the world GDP, I should invest only 3% of my portfolio in India. Any more would amount to being biased towards India.

My investment advisor[2] told me that that's a dangerous strategy, and that I'm leaving myself exposed to exchange rate fluctuations. If, when I retire, the rupee has appreciated, I'll have a lower return[3].

He said that people should invest the majority of their money in the country they live in. Is that advice correct?

A third option is to invest exactly half in India, and half abroad. That way, I'm diversified equally between the two risks: the rupee appreciating, which is a risk with investing abroad, and the Indian market not generating a good return, which is a risk with investing in India. If one of these events occurs, its impact will be limited to just 50% of my money. Whereas, if I was 80:20 or 20:80, then one of these two events would put as much as 80% of my money at risk.

This is no different from the following hypothetical situation: say you're investing only in your country, and that there are only two companies available for you to invest in. You'd invest 50% in each stock, unless you have a reason to think that one company will give you a higher (risk-adjusted) return. Applying this logic to the question at hand, the conclusion is to invest 50% in one market (India) and 50% in the other. Is this logic correct?

Should I invest the majority of my money in India, abroad, or 50:50?

Footnotes:

[1] I also have non-equity investments, but they are irrelevant to this question, so let's pretend they are zero, to keep things simple.

[2] Who I no longer work with, unfortunately.

[3] Further, this risk can't be diversified: If I invest money in the UK, Germany, France and Japan, I'm diversified against the risk of one of these currencies, say the yen, depreciating against the rupee, but I'm not diversified against the risk that that the rupee appreciates against all these currencies.

Answer 1

Your definition of 'outside your country' might need some redefinition, as there are three different things going on here . . .

1. Investment in shares of your home country's indices and companies (versus abroad)
2. Investments made through a brokerage firm in your home country (versus abroad)
3. Investments made in your home country's currency (versus a foreign currency)

Your financial adviser appears to be highlighting the currency risk associated with point three. However, consider these risk scenarios . . .

A) Your country enters a period of severe financial difficulty, and money markets shut down. Your brokerage becomes insolvent, and your investments are lost. In this scenario the fact of whether your investments were in an overseas index such as the S&P, or were purchased from an account denominated in a different currency, would be irrelevant. The only thing that would have mitigated this scenario is an account with an overseas broker.

B) Your country's stock market enters a sustained and deep bear market, decimating the value of shares in its companies. In this scenario the fact of whether your investments were made in from a brokerage overseas, or were purchased from an account denominated in a different currency, would be irrelevant. The only thing that would have mitigate this scenario is investment in shares and indices outside your home country.

Your adviser has a good point; as long as you intend to enjoy your retirement in your home country then it might be advisable to remove currency risk by holding an account in Rupees. However, you might like to consider reducing the other forms of risk by holding non-Indian securities to create a globally diversified portfolio, and also placing some of your capital in an account with a broker outside your home country (this may be very difficult to do in practice).