So far this year, an increase in international tensions has repeatedly impacted financial markets--and perhaps even your own portfolio. Unrest in Ukraine and Russia has left a trail of short-lived dips in stock charts since late January, and is now joined by escalating war in Israel. In addition, attacks in Iraq that began in June are limiting oil supply and pushing up energy prices. And as each new conflict arises, gold prices jump higher as investors seek "safe" investments.
A decline in stocks or a jump in gold prices is typically the immediate, and often temporary, result. Despite wobbles, domestic stocks are up more than 8% and international stocks have gained more than 4% for the year, through mid-July. But what happens in the longer term if geopolitical tensions don't ease quickly?
First, the interruption caused by geopolitical conflicts can hamper individual companies, which could ultimately impact a country's overall economic growth. The violence in Israel, for example, led to a temporary ban on flights that will likely restrict profits for airlines that service the area. And the longer the violence goes on, the deeper it will cut into tourism profits that were on track to set a record high in 2014, and which make up about 6% of Israel's economy.
Beyond individual economies, conflicts like those in Iraq can affect nearly every region of the globe. While Americans are familiar with higher prices at the gas pump when crude oil prices rise, expensive crude can be much more damaging: It can eventually drive up inflation, a threat to both developed and developing economies. Many fragile emerging-market economies rely heavily on oil imports, which can be unsustainable if prices rise.
A further ripple effect is that rising inflation can influence bond markets. Because bonds have a fixed coupon, rising inflation can gradually erode their purchasing power over time. In response, investors will begin demanding higher yield to offset that inflation. But in chasing that higher yield, investors may also be taking on greater risk.
There are many opportunities available in international stocks and bonds, and they can complement a wide array of other assets within your portfolio. But it can be difficult to discern the difference between short-term noise abroad and full-fledged crisis, and to predict how wide reaching the ripple effect may be.
In short, rising tensions overseas have served as a stark reminder why diversification is so critical to investment success. Risk is an inherent part of investing, and sound portfolios are built by taking a variety of risks into consideration. The advantage to turning to professional, actively managed mutual funds is that they have the research and resources to spend significant time studying the areas where geopolitical threats like these arise, and to adapt their investments appropriately when necessary.
Past performance is not indicative of future results. Indices are unmanaged and not available for direct investment.
All investments are subject to risks, including possible loss of principal. Fixed income investments are subject to interest-rate risk, credit risk, and call risk. Foreign investments are subject to additional risks. Diversification does not ensure a profit or protect against a loss in a declining market.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The article has been written by Hartford Funds' Investment Team. Hartford Funds is not receiving compensation for it. Hartford Funds has no business relationship with any company whose stock is mentioned in this article.