For many, investing in foreign stock markets can be a challenging way to balance a portfolio, though the outcomes can often be rewarding. Investors that do get involved have the opportunity to participate in the long-term growth prospects of many emerging markets – markets that have faster growth rates in comparison with those developed nations.

Successful investing requires the understanding of the risks of investing in these types of markets, and how to buy stocks in the foreign markets.

Issues with Foreign Stock Markets
Investing in foreign stock markets presents a host of challenges, as compared with investing in domestic markets. Successful investors know what these obstacles, are and have devised strategies to overcome them to provide their portfolios with greater returns. Below we will examine some common risks, including lack of transparency, currency risk, volatility and finding ways to buy in these markets. (Fore more, read our related article Evaluating Country Risk For International Investing.)

Lack of Transparency
Many emerging, and some developed, markets do not have the same types of reporting standards as the United States. For example, the Securities and Exchange Act of 1934 requires all companies that are listed on any U.S. Stock Exchange to report their earnings quarterly, and file the appropriate documentation with the Securities and Exchange Commission (SEC) on a regular basis.

These could include 10Ks, 10Qs and other types of documents. In other countries, these laws do not apply, and it could be difficult to find accurate information on the company – never mind the fact that the information found may not be in English. Also, surprise political or economic events can affect the investment.

Currency Risk
When the currency of the country in which the investment is made appreciates, in comparison to the U.S. dollar, the value of the investment is worth more money. On the other hand, when it depreciates against the U.S. dollar, the value of the investment may be worth less. Also, some countries could impose currency restrictions that could delay or stop the ability to "cash out" of the country's currency. (Read more in our related article, Protect Your Foreign Investments From Currency Risk.)

Buying in Foreign Markets
Buying a stock in these different markets can be challenging, to say the least. Brokers don't always have access to specific markets, and cannot perform certain trades. When brokers are able to make the trade, reporting and clearing times may be longer than in U.S. markets, making for longer settlements. Also, the safekeeping of the shares might not be protected against fraud or theft, if the bank or brokerage firm goes under.

Volatility
Foreign stock markets can be volatile at times. These markets can have huge swings, both up and down. This can be more extreme in comparison with the U.S. markets, due to insider trading, manipulation or other factors. A good example of this occurred in Mexico in 1994.

Between 1989 and 1993, Mexico was able to control inflation and reduce its mounting foreign debt. Prior to 1994, the peso was pegged at a fixed rate to the U.S. dollar. When the government decided to widen the trading band from 3.47 to 4, there was a massive collapse in the peso, causing stocks on the Bolsa Mexicana de Valores (Mexican stock market) to decline as much as 60%.

It is important for investors in these markets to focus on long-term factors. While the markets can be volatile at times, the day-to-day up-and-down swings should not deter eager investors. There are many ways to become involved in foreign stock markets without having to deal with many of the above risks, such as American depository receipts (ADRs), exchange-traded funds (ETFs) and mutual funds.

American Depository Receipts
American depository receipts (ADRs) are foreign stocks that trade on U.S. stock exchanges. These are generally larger, more stable companies that are subject to U.S. listing and reporting standards. They have to file all appropriate documentation with the SEC, just to be listed. ADRs should be treated just like regularly-listed securities, as far as the inherent risks that go hand and hand with trading equities. (For more on ADRs, see our ADR Basics Tutorial.)

Exchange-Traded Funds
An exchange-traded fund is a fund that trades on a U.S. stock exchange that tracks an underlying index. It trades similarly to a stock, and can be bought and sold throughout a trading day. ETFs can be used to follow an index which correlates to a particular country or region. This creates more diversification by spreading out risk.

ETFs are required to follow U.S. reporting standards. The disadvantage of ETFs is that they could become volatile at certain times, as they may follow indexes from different countries. (For more on ETFs, see our Exchange-Traded Funds Tutorial.)

Mutual Funds
A mutual fund is an investment company that pools the money together from many investors. That money is used to invest in stock, bonds and other areas. The basic idea is that mutual funds can provide diversification by allowing investors to spread out the risk among many different areas. Mutual funds allow investors to dive into foreign markets in many ways, and the types of funds vary. Below are some of the types that investors can use:

  • Global funds invest mainly in foreign companies, but can also invest in U.S. companies.
  • International funds invest in specific companies outside the of the United States.
  • Regional and country funds invest in a particular region or country.
  • International index funds track the index of a particular country's stock market.

Also, mutual funds are usually more diversified, so they can lessen some of the potential volatility.

However, like with ADRs and ETFs, they could be subject to the up-and-down swings that can occur in a market. As well, mutual funds tend to have numerous fees and loads which may deter many potential investors from buying in. (For more on mutual funds, see our Mutual Funds Tutorial.)

Conclusion
Investing in foreign stock markets can be challenging and rewarding, but these markets have their own exclusive hurdles. Buying ADRs, ETFs and mutual funds can help reduce some of these risks. All three are subject to American listing standards, trade in U.S. dollars and can be purchased through brokers. Still, market volatility can influence these investments at times, so long-term focus and caution are still important. (To read more on investing in foreign markets, read How Do I Invest In Foreign Stock Markets?, Pros And Cons Of Offshore Investing and Investing Beyond Your Borders.)

Related Articles
  1. Mutual Funds & ETFs

    The 4 Best T. Rowe Price Funds for Growth Investors in 2016 (TROW)

    Discover the four best mutual funds administered and managed by T. Rowe Price that specialize in investing in stocks of growth companies.
  2. Mutual Funds & ETFs

    The 3 Best T. Rowe Price Funds for Value Investors in 2016

    Read analyses of the top three T. Rowe Price value funds open to new investors, and learn about their investment objectives and historical performances.
  3. Mutual Funds & ETFs

    Top 3 Lazard Funds for Retirement Diversification in 2016

    Learn about Lazard Asset Management, its long history of strong performance and the top three Lazard funds to consider for retirement diversification.
  4. Investing

    3 Healthy Financial Habits for 2016

    ”Winning” investors don't just set it and forget it. They consistently take steps to adapt their investment plan in the face of changing markets.
  5. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  6. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  7. Markets

    Is It Time To Buy Emerging Markets? (EEM)

    The majority of emerging markets are dependent on natural resources, delaying a long-term recovery until commodity markets end historic downtrends.
  8. Investing Basics

    How liquid are Fidelity mutual funds?

    Review the liquidity features of mutual fund shares and an overview of Fidelity mutual funds. Most investors look for convenient access to their investments.
  9. Mutual Funds & ETFs

    Which Fund Share Class is Best for Retirement?

    Mutual funds are a popular investment for retirement. Here's how to choose the best share class when investing in them.
  10. Mutual Funds & ETFs

    Top 5 Wellington Funds for Retirement Diversification in 2016

    Discover the top five Wellington Management funds for retirement diversification in 2016, with a summary and performance details of each fund.
RELATED FAQS
  1. What's the difference between a stop and a limit order?

    Different types of orders allow you to be more specific about how you'd like your broker to fulfill your trades. When you ... Read Full Answer >>
  2. Are target-date retirement funds good investments?

    The main benefit of target-date retirement funds is convenience. If you really don't want to bother with your retirement ... Read Full Answer >>
  3. Do mutual funds require a demat account?

    A dematerialized account enables electronic transfer of funds. The account is used so an investor does not need to hold the ... Read Full Answer >>
  4. Are secured personal loans better than unsecured loans?

    Secured loans are better for the borrower than unsecured loans because the loan terms are more agreeable. Often, the interest ... Read Full Answer >>
  5. Is Malaysia a developed country?

    Despite undergoing rapid economic development over the past five decades, Malaysia is not considered a developed country, ... Read Full Answer >>
  6. How liquid are Vanguard mutual funds?

    The Vanguard mutual fund family is one of the largest and most well-recognized fund family in the financial industry. Its ... Read Full Answer >>
Hot Definitions
  1. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  2. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  3. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  4. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  5. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
Trading Center