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Why You Should or Should Not Invest Overseas
Why You Should or Should Not Invest Overseas
By Douglas Charney
Are you interested in more portfolio diversification than is available in the United States stock market? Or do you find the vast range of opportunities available in international equity markets enticing? Like many savvy investors who desire new alternatives, you may look to security options abroad. But before you jump borders, consider the following pros and cons of overseas investing:
Because of its huge economic size, the U.S. is truly a global leader, but its economy cannot possibly grow at the same rate as some developing nations without triggering inflation. On the other hand, China’s GDP has grown nearly 8 percent per year since 1980.
In addition, foreign countries host some of the world’s largest companies. For instance, Nestle is based in Switzerland, Royal Dutch Shell and Chicago Bridge Company are located in the Netherlands, and GlaxoSmithKline is located in the United Kingdom. Even if you don’t use any of these companies’ products, you’ve at least heard of them.
Another positive aspect is more diversity. Global investments can produce portfolio volatility and may even increase your returns. Ups and downs in the stock market are caused by numerous factors, including investor perception, interest rates, and political environment. These factors, however, are not the same worldwide, and foreign stock markets don’t usually mirror the U.S. stock market. So, international investing may help counterbalance any severe domestic drops…and vice versa.
Every Positive Has a Negative
Global investing offers many potential rewards, but it also involves some risks worth considering. First, every international stock is priced in the currency of that company’s country. For example, a German company’s stock is priced in Euros, so the value of the investment will hinge partly on the exchange rate between Euros and Dollars. In fact, investors may experience difficulty in determining the actual value of their foreign stocks because of constant fluctuations in the exchange rate.
Also, beware of potential political risks with foreign investments. Major political events, such as elections, trade agreements, tax changes, and civil unrest can threaten foreign markets. An example of this would be the political and economic problems that affected Mexico in 1994. Mexican stock and bond prices took big losses during this period of Mexican economic unrest. Many times, these events occur with little or no notice. International investors must keep watch on the political and economic stability of foreign countries.
Overseas investors must also keep in mind that foreign governments don’t regulate their companies in the same ways as the U.S. government. They don’t require the same levels of disclosure, and their accounting rules are quite different. Japan’s accounting rules, for instance, are dissimilar from the U.S. accounting procedures. These inconsistencies make investment research more difficult and quite time-consuming.
Liquidity of foreign stocks can pose another problem for investors. Foreign stock markets generally trade at lower volumes than domestic markets, making trade difficult with some securities in the absence of supply or demand. This lack of liquidity, which makes trade profitability awkward, will be more of a problem in developing markets, where volume can be very light.
What Are Your Options?
Before making any decisions which could affect your financial future, always weigh the pros and cons. You should never make uncalculated decisions, especially in foreign investing. And if you do decide to diversify your investment portfolio with foreign securities, several options exist. As an individual, you have the option of purchasing American Depositary Receipts, or ADRs, for foreign stocks. An ADR becomes available when a U.S. financial institution buys shares of a foreign company, translates the exchange, and then resells the receipts on a domestic market. The company retains the stock certificate and pays investors in U.S. Dollars. ADRs offer a higher liquidity and easy transaction process, but are usually limited to major companies throughout the world. ADRs have increased in popularity among investors and therefore, the quantity available continues to rise. You must, however, do all your own research on ADRs, and many times the information available on these companies is rather limited.
Other methods of international investing are either global mutual funds, which include U.S. stocks, or international mutual funds, which exclude U.S. stocks. These types of mutual funds offer you access to professional research and managers with several years of experience in international investments. Because mutual funds own more stocks from more countries than most individuals can obtain, they may offer more diversification and less risk. Mutual funds are sold by prospectus. The prospectus contains complete information an investor should consider including investment objectives, risks, charges, and expenses, as well as other important information about the investment company. Your financial advisor can provide you with a prospectus for any fund you may be considering. Read it carefully before you invest.
In fact, guidance from a qualified financial advisor is always a good idea, especially if you’re a novice global investor. Your advisor will buy and sell on your behalf, based on your investment policy. Many financial advisors offer professional management and research plus experience with international markets. In many cases, your financial advisor will actually set up the ADRs, giving you access to more foreign securities than an individual.
International Investment Conclusions
U.S. economic downturns and wartime politics make foreign securities more appealing to investors. If you’re looking for additional ways to diversify your portfolio, the international market offers many choices. International markets aren’t affected by the same variables as the domestic market, and many of the giant corporations whose products we use every day are based in other countries.
International markets are quite different from the U.S. market, however. Foreign companies aren’t regulated by the same governmental criteria as U.S. companies, usually have low liquidity, and their value may be difficult to determine due to fluctuations in exchange rates. Your decision on whether to invest internationally will ultimately be based on a number of factors and personal preferences. A qualified financial advisor can assist you with all the details. Then when you use that information to weigh your options, you’ll be better prepared to make responsible investment decisions.