Investment Knowledge Center
The Investor with the Most Knowledge has the Advantage
When you want to learn how to invest internationally, about the biggest mistake you can make is to jump right in before you gain the right knowledge and understanding of the opportunities, the risks, the regions and the different markets. Each mistake can cost an investor a big loss, so it is important to develop your global knowledge and investing skills.
Many investors will invest in companies that they know, which results in an investment philosophy known as home-market bias. According to experts, the optimal allocation for international investments, when returns are maximized and the portfolio volatility is minimized, will range from 20% to 40%, based on personal preference and risk tolerance.
What is International Investing
International investing refers to buying and holding securities issued by companies or governments that are outside an investors home country. By investing globally, a portfolio will become more diversified which can enhance returns and reduce portfolio risk but owning foreign securities also exposes investors to unique risks such as those that result from changes in exchange rates, foreign interest rates and geopolitical events.
Risks in International Investing
- Access to Different Information: Many companies outside the United States do not provide an investor with the same type of information as public companies that are in the United States. In addition, the information may be in the native language only and not available in English or other languages.
- Costs of International Investments: International investing can be more expensive than investing in U.S. companies. In some countries, there may be unexpected taxes, such as withholding taxes on dividends. In addition, transaction costs such as fees, broker's commissions and other taxes may be higher than in U.S. markets.
- Working with a Broker: If an investor plans to work with a local broker, they should make sure the investment professional is registered to trade on the local market or exchange. It is important to conduct due diligence on the quality and the reputation of the individual broker and their firm.
- Changes in Currency Exchange Rates: When the exchange rate between the home currency, such as the U.S. dollar for investors in the United States, and the currency of an international investment changes, it can increase or reduce the investment return. This type of risk is known as currency risk or foreign exchange risk.
- Changes in Market Value: All securities markets, including those outside the United States, can experience dramatic changes in market price and value. This is known as price risk.
- Political, Economic and Social Events: It is difficult for an investor to understand all the political, economic and social factors that will influence markets, especially those abroad. This type of risk is known as geopolitical risk.
- Different Levels of Liquidity: Markets outside of the United States may have lower trading volumes and fewer listed companies than in U.S. markets. Additionally, the markets may only be open a few hours a day and some countries will limit the amount or type of securities that a foreign investor may purchase. This type of risk is known as liquidity risk.
- Legal Remedies: If there is a problem with their transaction, investment or broker, an investor may not be able to seek the same legal remedies that they would receive in their home country. Even if they sue successfully in a local court, they may not be able to collect on a judgment against a foreign entity. The only option may be to rely on legal remedies that are available in the company’s home country, if any.
- Different Market Operations: Foreign markets may operate differently as compared to U.S. markets or other major trading markets. The risk can also be applied to times when an investor is exposed to unexpected changes in the governing laws. This type of risk is known as jurisdiction risk.
5 Ways to Invest Internationally
Direct Investment in Foreign Stocks and Securities
The most obvious way to invest internationally is to buy shares of foreign companies. In some cases, this can be quite easy, because many foreign companies list their stock on major U.S. exchanges, like the New York Stock Exchange (NYSE) or the Nasdaq. Investing in these companies is the same as buying shares of any U.S. company. In addition, investors will benefit from these companies typically having to comply with the U.S. regulatory and financial disclosure rules.
For stocks that are not listed on a major U.S. exchange, investing gets more slightly more complicated. Some foreign companies trade on an over-the-counter basis, which makes them available through a local brokerage account but it may also make them less liquid. Other foreign stocks and securities would need to be acquired through transactions on foreign stock exchanges. Depending on the exchange rules, a limited number of registered brokers may be available to buy and sell foreign stocks on an exchange.
A depositary receipt is a negotiable instrument that is issued by a bank to represent shares in a foreign, publicly traded company. This type of security gives an investor the ability to invest foreign stocks. In general, a company will work through a depository bank to offer its equity shares in a foreign market. While a depository receipt can be structured in several ways, it lets an investor buy foreign stocks through their own domestic exchange.
American Depository Receipts (ADR), which are shares of a single foreign company issued in the United States, and Global Depository Receipts (GDR), which are shares of a single foreign company issued in more than one country, are two of the more popular types of depository receipts. Examples of other type of depository receipts include European Depository Receipts (EDR), Luxembourg Depository Receipts (LDR) and Indian Depository Receipts (IDR).
Internationally Focused Exchange-Traded Funds (ETF)
There are quite a few exchange-traded funds that will focus specifically on foreign securities. These funds provide a more diversified approach to international investing. Some international ETFs seek to offer a cross-section of the entire global stock market, while others tend to focus in on specific regions, countries, industries or other classifications of international stocks. One of the most common methods involve ETFs that focus on stocks in developed markets as compared to ETFs that concentrate on emerging market stocks.
An advantage of international ETFs is that they are listed on many major exchanges, including U.S. stock exchanges and they are easy to trade. Commissions, fees and transaction costs can be higher than with domestic stock ETFs so it is important to look closely at all the costs before you decide on investing in an international ETF.
An investment in a mutual fund can provide international exposure and diversification with several different options available.
- Global Funds: Investing primarily in foreign companies but may also invest in local companies. It is important to know how much of the portfolio is foreign and how much is local.
- International Funds: These will generally limit their investments to companies outside the local market.
- Regional or Country Funds: This type of fund will invest principally in companies located in a particular geographical region, such as Asia or Europe, or in a single country.
- International Index Funds: It will seek to track the results of a particular foreign market or international market index.
Multinationals with Sizeable International Operations
Finally, many companies or multinationals have dramatically increased their exposure to international markets over the past 20 years. With growth rates internationally often exceeding what a business can generate in mature markets, establishing a global presence has become increasing popular for multinationals, especially those that are based in the United States.
A few companies are almost entirely international focused. For instance, Philip Morris International only sells cigarettes and other tobacco products outside the U.S., leaving the domestic market to its former parent company. In other cases, companies may maintain a minimal local presence, but the nature of their business will make opportunities more readily available internationally. To get a better understanding of how global a company is, an annual report will usually break down revenue and profit sources geographically.