What is the risk associated with investing only in domestic markets?

Investing only in domestic markets exposes an investor to increased systemic risk. Systemic risk refers to the potential for a disruption in the financial system that can lead to broader economic downturns, typically influenced by factors affecting the entire market rather than specific sectors or companies.

When an investor concentrates their portfolio within one country's market, they are more vulnerable to economic events, policy changes, or geopolitical issues that can negatively impact that specific market. For instance, if the economy of the country experiences a recession or faces significant regulatory changes, the value of investments can decline significantly without the cushion of diversification that comes from international investments.

In contrast, diversifying across global markets can help mitigate these risks, as different markets may respond differently to various economic conditions. International assets can provide opportunities for growth even when domestic markets are underperforming, thereby offering a layer of protection against systemic risks faced by a single market.

Other options, such as increased diversification or lower return potential, do not appropriately capture the core issue of systemic risk that arises when one is exclusively invested in domestic markets. Higher liquidity risk is also more related to the specifics of individual securities or markets rather than the broad systemic risk inherent in a lack of diversification across geographies.