Investing directly in stocks
Many foreign companies follow all the listing rules and are listed on American as well as other major exchanges. It is not unusual for big companies to be traded in New York, London, and Tokyo. Also note that many American companies derive large part of revenues from abroad, thus in a sense are partially foreign.
There are also American Depository Receipts (ADRs), which are shares of foreign companies traded in the US. These companies didn’t comply with all the regulations to be listed directly, thus they trade in this form. That’s not to say they’re poor companies, just their managements decided not to go through the entire compliance processes.
Some foreign companies may trade on lesser exchanges where compliance rules aren’t that strict as with the New York Stock Exchange (NYSE) or NASDAQ.
Investors can also invest directly in foreign countries. Nowadays, many online brokerage houses offer direct access to foreign exchanges.
Other international investing alternatives
In addition to stocks and mutual funds, investors can buy foreign bonds as well as trade foreign currencies. Investing in real estate abroad is an option, too. Many wealthy investors, for example, buy properties in places like London or Singapore. Additionally, there are funds that specialize in foreign exchange, bonds, and real estate.
Benefits of international investing
Studies have shown that international investing can increase returns without increasing risk. In many cases, risk will drop as investments are internationally diversified. While one country’s stock market may perform poorly, some other foreign markets can do well. In addition, investors have more options to screen in order to find good opportunities.
Risks in international investing
The risks in international investing are multiple. There are political, economic, legal, and currency risks. To give an example, a war may occur or a foreign government (as it happened in the past in Africa and Latin America) may nationalize certain industries. The legal and accounting standards are often different, which makes it more difficult to analyze financial statements. And some foreign markets are more prone to stock price manipulation.
Another risk is the currency risk. Let’s say you invested in an index fund in Japan. During the year, Japanese market (and your fund as well) went up 10%. Now, let’s say you want to sell and take the money back to America. So, you need to exchange yen for dollars. But, if during this period of time yen declined 5%, your actual gain will be 5%. On the other hand if yen appreciated by 5%, your gain will be 15%.
Some investors actually like to invest in foreign currencies or stocks as a diversification against decline of their own currency. Since in a global economy much of stuff is imported, a decline in your nation’s currency will make imports more expensive, which will lower your purchasing power. Holding part of assets in other currencies diversifies that risk away.
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Although many investors fear international investing, it has its own benefits as it expands opportunities and allows for better diversification of a portfolio. Here, we describe different ways to approach it, as well as the pros and cons of international investing.
International markets offer expanded investment opportunities
A very simple way to invest internationally is through mutual funds. Global mutual funds not only invest around the world but also in the United States. The international funds invest outside of the United States. This is, of course, from a point of view of an American investor. If you’re not sure, check out the mutual fund’s prospectus or fact sheet to find out where the fund is investing.
Regional mutual funds are a different, more specialized kind. These vehicles invest in a particular region. For example, you may want to invest in emerging markets in South-Asia or frontier markets in Africa. There are plenty of funds that cater to such needs.
To get even more specific, an investor can choose a country fund. It invests in a particular country such as Japan, China, India, and so on.
Closed-End Funds and Exchange-Traded Funds
Closed-end funds trade like stocks. Although they have a Net Asset Value, the shares can trade at a premium or discount to it. There is a selection of closed-end funds catering to international investors.
Exchange Traded Funds trade as stocks, too, and are a cheaper alternative to mutual fund investing. Many follow a specific index and are passively managed. The variety of investment options offered by ETFs is enormous. For instance, there are BRICS ETFs, investing in Brazil, Russia, India, China, and South Africa. These offer relatively diversified investing in emerging markets.