A new economic world order is forcing many investors to look at the rest of the world to make a buck. With a volatile and uncertain U.S. economy these days, investors are researching more options and (hopefully) better returns by seeking other investments from around the world. Searching for growth outside U.S. borders may be a wise decision: Foreign markets make up roughly 60% of the world’s market capitalization (investment opportunities), and that figure is increasing.
However, international investing exposes investors to different risks that usually do not impact domestic markets. These risks may include: political instability, higher tax rates, reduced liquidity, and currency risk. Before including international investments in your portfolio, it is a good idea to review and understand the unique characteristics of global markets.
Emerging Market or Developed Market?
When considering investments outside of the United States, countries are commonly grouped into one of two categories: emerging markets and developed markets. Developed markets include nations with more traditionally stable economies, such as Germany, England, France, and Japan. Emerging markets are typically those nations that are moving toward becoming more established, but still demonstrate higher-than-average volatility, such as the “BRIC” nations: Brazil, Russia, India, and China.
How to Invest in Foreign Securities
Investing in foreign securities, or at least providing some international exposure to your portfolio, is easier than you might think. Perhaps the easiest way to include foreign exposure is simply to invest in very large U.S. companies, such as McDonald’s, Microsoft, and Coca-Cola. These companies have a worldwide presence and significant amount of their revenue comes from foreign companies.
If you wish to invest directly in stocks of foreign companies, you can do so by purchasing American Depositary Receipts (ADRs) or by investing in mutual funds that invest in foreign companies. ADRs are negotiable certificates that represent the shares of a publicly traded foreign company. These instruments are issued in the United States, and the underlying shares are held in U.S. banks.
Keep in mind, access to specific information about foreign companies can be difficult to obtain, and understanding international markets (and their associated risks) is time consuming. Buying shares of broadly diversified international mutual funds or exchange-traded funds that may buy a mix of foreign and U.S. stocks is a fairly simple approach.
Currency Risk: A Special Consideration for International Investing
International investing can provide additional diversification as part of your overall risk management process, but it also poses unique risks and opportunities. A U.S. investor’s foreign-investment return is based on not only the stock price, but also on the local currency’s exchange value against the U.S. dollar. For example, falling currency values and plummeting stock prices in Asian nations in 1998 not only drove down stock prices for international investors in Asia, but also in the United States, because many American companies depend on Asia for customers.
For U.S. investors, currency gains or losses could also stem from a fluctuation in the dollar’s value against the currency of the foreign country in which they are investing. Keeping a long-term perspective and diversifying across a variety of international investments can help reduce these risks.