Advice for Recent Grad (24 yrs old) - Emerging Markets Allocation?

(Not sure if this is the right place to post this question, please tell me if it's not)

I'm a recent college graduate learning to manage a 401k (and just money in general) for the first time.

My question is what percentage (if any) of my account I should put into Emerging Markets? And what the reasons for and against this might be.

I've always been told that at my age I should be willing to accept greater risk in my portfolio, which makes me inclined to put a pretty sizable percentage into the emerging Markets.

To give you some numbers, I'm with Vanguard right now, and I currently have 100% of my portfolio in their "Target Retirement 2050" account (VFIFX).

However, their Emerging Markets Index Fund has a 36% annual return over the past 5 years (VEIEX). And since I've also heard speculation that the Emerging Markets may be less severely hit if we go into recession, this makes me inclined to re-balance my allocation.

On the other hand, the Emerging Markets fund has done worse over the past month than the Target Retirement fund. But is this just reflective of the greater volatility of the Emerging Markets, and shouldn't concern me, or is indicative of something greater, like this being a bad time to get into Emerging Markets?

So, overall, apart from just seeking general advice, my specific question would be: at 24 years old, is there any reason not to put 30% to 50% of my 401k into Emerging Markets?

Psychologically, I should probably add that I understand statistics and the "long term", and thus am probably fairly mentally capable of weathering short-term volatility *if* it's within the context of a sound long-term strategy. But I would need to be reasonably confident that the strategy is a sound one, hence the request for advice.

I'm *very* new to all of this, really learning how to manage money for the first time in my life, so I'd really appreciate as much explanation as you're willing to give with your answers.

Thanks a bunch!

30% to 50% in emerging markets would be crazy, at least in my opinion. That amount in total international makes sense to me. But only about 20% of your international allocation should be in emerging markets. VFIFX is only about 18% international, which is too light for my taste, but the emerging market portion of that is around 20% which is solid. I would go with something like the FTSE all world ex US or Total International Stock Index to bump up your international exposure. Don't go buying from the top of the short term perfomance charts. Emerging markets are extremely volatile and have huge downside risk. There's a big difference from intellectually understanding this and getting kicked in the gut by it when it drops off a cliff. The greater risk you can assume as a younger person is to be largely in equities in general. But you still need to have a sensible diversified allocation in equities.

I think a 30-50% allocation is a bit high. But if roller coaster rides can be your thing, why not? Who am I to tell YOU what to do? If you want the 33% positive returns, what will you do if you get -33% returns (the negative end is just as possible as the high end). I would invest in equities, but be more diversified.

I would suggest an allocation which looks like this:

75% domestic stocks, 25% foreign stocks
45% domestic large cap
15% domestic mid cap
15% domestic small cap
15% foreign large cap (developed markets)
10% foreign small cap and/or foreign emerging markets

logic (my own): emerging markets will be small companies, small countries and small stocks. Many foreign large caps will actually be mid caps based on size if they were US stocks, in many cases the market cap of some entire emerging markets is smaller than the average small cap stock in the US. You might know these as penny stocks here in the US (would you put 50% into penny stocks?).

Foreign investing also has currency risk. We have about 10 months left of Bush's weak dollar economic policy. That weak dollar inflates returns of foreign investments, but if the dollar gets stronger, currency risk will rear it's head and decrease the return (even if the actual companies in the mutual funds were good investments).

I would limit the investing in really small companies, I would limit exposure to currency risk, and I would limit making large bets anywhere in portfolio. Keep it divided within reason.

A 10% emerging markets position in a 10k portfolio will return $300. That's the 30% return you spoke of before.
A 45% domestic large cap position in a 10k portfolio will return 8% on average, which much more consistency (less volatility) historically. That 8% return returns $360.

So I would argue the 10% position is riskier, and delivers a lower absolute dollar figure even with the return which is 4X higher. The 8% return is much more realistic year over year, where as the 30% returns are not sustainable for any amount of time.

Which return makes more sense to build a long term strategy with?

Thanks for the replies so far guys, definitely appreciate the advice.

So, newbie question number 1: What does "Large cap/med cap/small cap" mean? Is it referring to the size of the company or the percentage of its market share, or something else?

Thanks for the replies so far guys, definitely appreciate the advice.

So, newbie question number 1: What does "Large cap/med cap/small cap" mean? Is it referring to the size of the company or the percentage of its market share, or something else?

large cap is probably a market capitalization of more than $5 billion.
mid cap is probably a market capitalization of between $2 billion and $5 billion.
small cap is probably a market capitalization of less than $2 billion.

Market capitalization is the amount of stock the company has on their market. It is the amount someone would have to pay to buy all the remaining stock of the company.

Microsoft is $286 Billion. GE is $363 Billion. GM is $16 Billion. By these measures GE is about 50% bigger than Microsoft, and Microsoft is almost 18 times bigger than GM. And all 3 are considered among the biggest companies in the world.

Market caps are ranges. Different people will use different criteria for what large-mid-small is.

But keep in mind small is relative. If a company has a market cap of $500 M and 2000 employees in the USA, that is clearly small and tiny. If that same company is in Somalia, it might be the largest company in the country. So when dealing with emerging markets, the funds are often dealing with companies much smaller than anything found in the USA. The emerging market company might be the size of that local business around the corner to you, but because it's in another country, it might have better prospects for growth (but also similar prospects for being corrupt if given too much money).

Thanks for the replies so far guys, definitely appreciate the advice.

So, newbie question number 1: What does "Large cap/med cap/small cap" mean? Is it referring to the size of the company That's a fair way to look at it, from a high/basic level. Jim of course explained it well above (both posts were great IMO).

Anyway I agree 30%+ is too much for emerging mkts, but as for an overall split of your investments, I personally would go a little riskier than what Jim said above......but that's me. You have to decide for yourself just how risky you want to be, keeping in mind the younger you are, the more "leeway" you have to do so, ie recover from if it doesn't work out...but that isn't to imply that just because you're young that you should throw caution to the wind either.

I suggest hooking up with a recommended financial advisor. You can start with your bank, who I would think/hope offers that service for free (that doesn't mean you should automatically let them handle it though).