What is a potential trade-off of geographic diversification in a portfolio?

• A. Higher returns with no risk
• B. Increased currency and geopolitical risk
• C. Eliminates all country-specific risk
• D. Lower liquidity

Answer: (B)

Geographic diversification reduces exposure to the fortunes of any one country, which can smooth out country-specific downturns. But it introduces currency and geopolitical risk. When you invest abroad, returns are affected by movements in foreign currencies relative to your home currency, which can add volatility and reduce or enhance gains when you convert back. Political events, sanctions, policy shifts, or regulatory changes in different regions can also impact markets in ways that are not present domestically. These currency and geopolitical factors are the trade-offs you accept in exchange for potential growth opportunities abroad.

Higher returns with no risk isn’t accurate because diversification can improve the risk-adjusted return but cannot guarantee higher returns or remove risk entirely. Eliminating all country-specific risk isn’t true because some exposure remains, and broader or global risks can still affect multiple regions. Lower liquidity isn’t a guaranteed outcome of geographic diversification, as liquidity depends on the specific markets and assets involved.