As an investor, you may have heard exciting recommendations for investing internationally. There is almost always an economy somewhere that’s doing well – why not put your investing dollars there?
International investing is another way to diversify your portfolio. But what are the risks involved?
You may have been hesitant to invest your money in foreign companies, simply because you aren’t sure of the drawbacks. Let’s take a look at the risks, and you can decide for yourself if it makes sense for you.
If you want to purchase a foreign stock, there can be significant transactional costs beyond what you’re used to paying. These can vary dramatically from country to country. These extra fees can include exchange fees, taxes, levies, stamp duties and “clearing fees.”
If you want to avoid these additional costs, you can frequently purchase American Depository Receipts (ADRs), which trade in the US and have the same fee structure to which you’re accustomed. They’re not available for all companies, but the larger companies are well represented in the available ADRs.
One thing that investors often overlook is the risk associated with currency exchange. If you directly purchase a Japanese company, you’re going to have to exchange your dollars for yen. Even if the stock does well, consider what happens if the value of the yen drops compared to the value of the US dollar.
You could actually lose money if you decide to cash out, even though the stock went up. But consider that you could also make money, even if the stock goes down.
The value of the foreign currency relative to your base currency is always a variable that you must consider. Of course, you always have the option of leaving your money in the foreign market until the currency situation is more favorable.
There are many complex ways to hedge against currency issues by the use of futures, options, and more, but those options come with their own costs and risks.
While many markets respond quickly to sell orders, like the US, many do not. It’s not always easy to unload your stock quickly when the time comes. While there are ways to protect against currency-related risks, there is no good way for the average investor to protect himself against the liquidity risks.
This is typically only an issue in emerging markets whose stock exchanges aren’t well established. One way to guesstimate a stocks liquidity is to look at the spread between the bid and the ask price. The greater the spread, the more likely that it will be slow to sell when the time comes. Also consider the volume: lower volume stocks are more difficult to sell.
The US has a lot of laws regarding the information that companies must provide to investors. The information is usually quite reliable, as well. This is not always true in other countries. You may not be able to get all the information that you’re accustomed to, and the information you do get might be suspect.
It’s going to take more homework in many cases to have the same level of comfort you have in the US.
International investing can be a great way to both diversify your portfolio and take advantage of any hot economy. While there are only a few risks beyond what you’re probably used to, it’s important to know the risks and adjust your approach accordingly.
The 4 main risks are transactional, currency, liquidity, and informational. Mange these risks and you can invest anywhere in the world.