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One of the thorniest decisions investors have to make is whether to put money into foreign stocks. Investing in foreign companies can be lucrative, but the rewards come with additional risks, and spotting worthwhile investments overseas can take a tad more work than finding them at home.
International Opportunity
There are plenty of good reasons to invest abroad. International stocks represent added opportunity: as of 2004, U.S. stocks represent only about half of the total value of global markets. In fact, not one of the 10 largest companies that make steel, electronics or consumer appliances are based in the United States. There are about 21 major stock markets outside of the U.S. that have more than a thousand companies of substantial size. Many of those companies operate in rapidly growing economies with extraordinary rates of return. Why pass them up? From a portfolio management perspective, investing in foreign companies is a way to diversify. For instance, U.S. and foreign shares do not always move in sync. When one is up, the other may be down, and vice versa. In technical terms, such markets are said to lack correlation. A diversified portfolio balances uncorrelated assets to spread the risk. Of course, that doesn't mean that U.S. and foreign shares always move in opposite directions. Many countries rely heavily on the U.S. for imports and exports, and can be susceptible to U.S. market shifts. In today's global economy, stocks often move in the same direction, especially when the U.S. is experiencing a big bear or bull market. Nevertheless, academic research shows that over the long term, U.S. and foreign shares are sufficiently independent so that investing overseas can smooth portfolio returns.
International Risk
Investors, however, need to appreciate the serious risks involved with international stocks. For starters, there is exchange rate risk. A U.S. investor's return on a stock from a foreign country is tied to changes in the currency values between the U.S. dollar and that country's currency. If you buy a Japanese stock and the Japanese yen rises against the dollar between the time you buy and sell the stock, your return is worth more. On the other hand, if the yen weakens, your investment return weakens.
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