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.
Tutorial: How To Analyze Earnings
There are plenty of good reasons to invest abroad. International stocks represent added opportunity: U.S. stocks represent approximately 30% of the total value of global markets. In fact, most of the largest companies that make steel, electronics or consumer appliances are based based outside of the United States, in countries such as Brazil and South Korea. There are well over a dozen 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? (Learn about the other side of this conversation in: Does International Investing Really Offer Diversification?)
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.
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.
Beyond upheavals in currency markets, there is country risk. Many countries suffer from political, social and economic instability, which makes investing in those places risky. (Learn more about risk in Evaluating Country Risk For International Investing.)
If you think that investing in your home country is hard, spotting companies in foreign lands can be even tougher. Foreign governments have different reporting and tax regulations on securities. In many cases, foreign companies are not required to provide the same detailed information U.S. companies must provide, and overseas companies may use different accounting procedures, which can make stock analysis trickier. Before putting money into an overseas stock, it's critical to get a good sense of its investment environment.
For investors with the patience to do their research, international stocks can offer big rewards. The trick is to understand the opportunities as well as the risks. Here are some straightforward ways to buy into foreign companies:
While many investors appreciate the rationale for investing abroad, they may be deterred by the mechanics of purchasing shares on a foreign exchange. American depositary receipts (ADRs) can simplify the access of U.S. investors to foreign markets. Listed on the New York Stock Exchange and Nasdaq, they can be traded, settled and held as if they were ordinary shares of U.S.-based companies. Foreign companies with ADRs issue financial reports that generally conform to U.S. accounting conventions and SEC rules. Companies with ADRs include Finland's Nokia, GlaxoSmithKline of the U.K. and Japan's Sony.
Although they trade on U.S. exchanges, ADRs still offer the potential benefits of diversification. Studies suggest that ADR prices tend to behave like the foreign stocks they represent. (For more on ADRs, take a look at ADR Basics or What Are Depositary Receipts?)
U.S.-Traded International Stocks
There are a few foreign stocks that trade on U.S. markets. These stocks have met the listing requirements of either the New York Stock Exchange or Nasdaq.
Before you jump into foreign stocks, it's worthwhile considering domestic stocks with exposure to foreign markets. Plenty of U.S. companies generate the bulk of their revenue from outside the U.S. Take McDonald's, Coca-Cola and Gillette. More than half of their revenues come from overseas business. Buying shares of U.S. multinationals can be an effective way for investors to get exposure to the global economy.
Because foreign markets lack direct correlation, investing outside the U.S. can be an effective way to diversify your portfolio. However, investing abroad can also expose you to risks associated with exchange rates, political or economic instability, and differences in reporting and tax regulations. Still, in understanding these risks in relation to the potential rewards, investors have the opportunity to access foreign markets through instruments such as ADRs, international stocks traded on U.S. exchanges and U.S. multinationals.
Mutual Funds & ETFsDiscover how the Vanguard Total International Stock ETF is managed, and learn which investors may find it suitable as part of a diversified portfolio.
Mutual Funds & ETFsFind out why mutual funds are not insured by the FDIC, including why the FDIC was created and how to minimize your risk with educated mutual fund investments.
ProfessionalsLearn about the various talking points you should cover when discussing mutual funds with clients and how explaining their benefits can help you close the sale.
ProfessionalsLooking for short-term fixes in reaction to market volatility? Here are a few strategies — and their downsides.
InvestingThe recent market volatility, while not unexpected, has certainly been hard for any investor to digest.
InvestingThe further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
Personal FinanceMany advisors display similar skillsets that can make distinguishing between them difficult. The following guidelines can help you better understand their qualifications and services.
Investing BasicsYou can never be sure of what the market will do at any given moment. That’s why a well-diversified portfolio is so important.
Mutual Funds & ETFsDiscover detailed analysis and information about some of the top exchange-traded funds (ETFs) that offer exposure to the investment-grade corporate bond market.
RetirementFind out why you should include balanced funds in your portfolio, including the importance of customizability, diversification and professional management.
There are several potential advantages available for an investor through using American depositary receipts (ADR) rather ... Read Full Answer >>
Mutual funds are legally allowed to invest in hedge funds. However, hedge funds and mutual funds have striking differences ... Read Full Answer >>
Mutual funds are considered a bad investment when investors consider certain negative factors to be important, such as high ... Read Full Answer >>
Financial advisors who operate as fee-only planners charge a percentage, usually 1 to 2%, of a client's net assets. For a ... Read Full Answer >>
While your auto insurance company cannot pull your full motor vehicle report, or MVR, it does pull a record summary that ... Read Full Answer >>
The Federal Deposit Insurance Corporation, or FDIC, is a government-run agency that provides protection against losses if ... Read Full Answer >>