Emerging Market Economy
What it is:
An emerging market economy describes a nation's economy that is progressing toward becoming more advanced, usually by means of rapid growth and industrialization. These countries experience an expanding role both in the world economy and on the political frontier.
How it works (Example):
Emerging markets have lower per-capita incomes, above-average sociopolitical instability, higher unemployment, and lower levels of business or industrial activity relative to the United States; however, they also typically have much higher economic growth rates.
Less developed nations throughout Asia, Africa, Eastern Europe and Latin America are said to be emerging market economies. The developed world consists of mature markets in North America, Western Europe and Japan.
Many emerging market economies become important bases for global manufacturing operations. At the same time, many emerging markets are enjoying booming export business. As they gain global presence, many emerging markets also benefit from regulatory reforms, cross-border trade, and loose monetary policy.
Why it Matters:
Emerging markets carry a much higher risk because their stocks can be quite volatile. Anything from inflationary pressures to rising interest rates to signs of a global economic cool-down could send them tumbling. Emerging markets investing carries other unique risks, such as political upheaval, regulatory changes, and currency fluctuations.
While emerging markets (and thus emerging markets funds) carry higher risk than the average investment, the potential for rapid economic growth in emerging countries means a higher return potential. Mature economies like England and the Unites States are often expected to grow around +3% annually, while emerging economies with ample room to grow have the potential to expand much faster. Going forward, this growth should translate into superior corporate profitability and impressive gains for investors.
Emerging markets are looking to sustain their growth. As a result, they tend to offer more capital gains opportunities than income opportunities. The majority of companies in emerging markets are choosing to invest extra cash back into the company rather than making substantial dividend payouts to their shareholders.