How To Invest In Foreign and International Stocks
Diversify your portfolio by adding foreign stocks -- here's how.The key to a balanced investment portfolio is simple — avoid putting all your eggs in one basket. Diversifying your portfolio by investing a portion in international stocks can help you benefit from the growth of other global economies while minimizing the risk caused by economic bubbles, downturns and political changes.
According to the World Bank, traded U.S. stocks amount to $33 trillion — almost half of the world’s total. Investors that haven’t looked at international stocks are missing out on companies like Chinese e-commerce giant Alibaba, Europe’s largest software company, SAP and the world’s largest contract computer chip manufacturer, Taiwan Semiconductor.
You can add international stocks to your portfolio by investing in U.S.-registered mutual funds or exchange-traded funds — but there are also other ways to achieve your goal, including trading in the international stock market.
Here’s a quick preview of what you’ll find in this guide to investing in foreign and international stocks.
- Ways To Invest In Foreign and International Stocks
- What Are the Benefits of Investing In the International Stock Market?
- What Are the Risks Behind Investing in International Stocks?
- Should I Invest In International or Foreign Stocks?
Ways To Invest In Foreign and International Stocks
As mentioned, there are several ways to invest in the international stock market. To make the best investment decision, ask yourself the following:
- How much time and research are you willing to invest in your international stock trading?
- What are your investment goals? (growth, income, etc.)
- When will you need the money?
- Which countries do you want exposure to, and which ones would you prefer to avoid?
- What fees or expense ratios are involved?
Once you have an idea of what type of investment goals you’re after and how you will invest in stocks, you can buy foreign stocks in the six following ways:
1. American Depositary Receipts (ADRs)
Depositary receipts allow foreign companies to raise funds in other international capital markets. Many foreign stocks access the U.S. stock market by trading as ADRs.
These receipts represent a ratio of shares of foreign stocks that correspond to the stock price’s home market price. The ratio isn’t always one to one. For example, one Vodafone ADR is equal to 10 shares, while one Toyota depository receipt equals two shares.
ADRs take the guesswork out of investing in foreign stocks by allowing investors to buy foreign stocks (in dollars) through a U.S. broker — without having to deal with the international stock market and foreign currency exchanges. But Anthony Denier, CEO of Webull, a commission-free trading platform, warns: “The ADR will trade in ‘parity’ with their locally traded counterparts, but beware that you may be subject to foreign tax structures on any dividend payouts.”
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2. Global Depositary Receipts (GDRs)
ADR and GDR are the same concepts with one main difference — global depositary receipts are also offered outside of the U.S. in international markets like Europe. ADRs and GDRs are usually traded in U.S. dollars, but GDRs may also be denominated in euros.
3. Direct Foreign Market Trading
Investors with higher risk tolerance and some global trading knowledge may have to buy foreign stocks directly when they aren’t available through the U.S. stock exchanges. Brokers like Charles Schwab allow investors to trade global stocks in foreign currency for many of the top foreign markets.
Direct foreign market trading is not for the occasional investor. Trading in the international stock market can be complicated — foreign exchange rates and special tax implications are just a couple of reasons. According to Morris Armstrong, Founder & Owner at Morris Armstrong: “Institutions are better equipped to handle this type of trading as compared to the average investor,” he says. “It is your responsibility to understand the rules of the country and the exchange that you are trading for.”
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4. Global and International Mutual Funds
Investors who’d like to diversify their portfolio by adding foreign stocks should consider global and international mutual funds. Global mutual funds are just like ordinary mutual funds — except they hold international stocks.
Like regular mutual funds, there are a variety of international funds available for all types of investing goals and risks. The four types of funds vary:
- Global funds invest in worldwide companies, including your home country
- International funds usually look outside the U.S.
- International index funds aim to track a foreign market’s growth
- Regional funds specialize in a specific country or continent
International mutual funds may have higher costs due to foreign exchange rates and taxes. Still, as an investor you may appreciate that an experienced group of professional fund managers is actively managing your investment.
5. Exchange Traded Funds (ETFs)
ETFs have similar benefits to mutual funds. Both invest in a diversified portfolio of stocks and bonds. Unlike mutual funds, ETFs trade on a stock exchange and can be bought and sold throughout the day as prices fluctuate.
International ETFs have lower expenses because they’re passively managed, meaning they track a country’s index. They offer opportunities to follow the growth of other economies and international emerging markets. Christopher Dhanraj, Head of iShares Investment Strategy, favors “ETFs focused on China (and Emerging Market Asia broadly), India and Brazil.”
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6. Multinational Corporations (MNCs)
Investing in MNCs is a way to dip your feet into international growth, but it should not be the primary way to diversify your investment portfolio internationally. MNCs like Coca-Cola or Ford Motors may operate worldwide, but they’re essentially U.S. investments. The bulk of your international allocation should go toward the other five foreign investment options listed above.
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What Are the Benefits of Investing In the International Stock Market?
A country’s equity performance tends to be cyclical. Diversifying your portfolio by adding a portion of international stocks can increase returns and reduce your investments’ volatility — one well-performing nation can make up for another underperforming country or region.
According to Fidelity, the percentage of foreign stocks you should own depends on your investment goals:
- Conservative: 6%
- Balanced: 15%
- Growth: 21%
- Aggressive growth: 25%
Like your overall portfolio, you should also diversify your foreign investment allocation. Avoid investing all 15% in a single country, for example. Aim for a mix of emerging and developed markets and small, medium and large-cap companies to spread out your risk.
Emerging markets are countries with young stock markets and shouldn’t be ignored. EMs make up 55% of the world’s gross domestic product in purchasing power, compared with 37% for developed markets like the U.S. and Europe. According to a Vanguard report, EMs which “successfully develop economically, politically and financially (such as the United States from the 1800s through the 1900s) would be expected to enjoy strong long-term equity market returns.”
Investing in stocks isn’t a “set it and forget it” process. Managing a portfolio is time-intensive. International mutual funds may be the best choice for hassle-free diversifying because they’re entrusted to a group of expert fund managers tasked with regularly reviewing and rebalancing the allocation to keep it consistent with the initial fund’s strategy.
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What Are the Risks Behind Investing in International Stocks?
Investing in international stocks adds a level of additional risk when investing. Some risks you should be aware of before trading foreign stocks and funds that can affect the value of international stocks include:
Changes in Foreign Currency
Stocks fluctuate in value, making the best timing difficult to predict. International stocks add another layer of uncertainty because international currency can increase or reduce your investment without warning.
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Geopolitical Events
Unless you’re a full-time trader, keeping up to date on all the economic and political factors that can affect the value of the international stock market is difficult.
Unregistered Investment Advisers
Working with a foreign broker not registered with the Securities and Exchange Commission may not give you the same protections as working with a registered U.S. broker. According to the SEC, “Investment advisers advising U.S. persons on investments in securities must register in the U.S. or must be eligible for an exemption to registration.” Make sure the foreign broker is registered with the SEC.
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Should I Invest In International or Foreign Stocks?
Achieving your financial goals requires balancing risk and reward. The right mix of investments is an art that requires research, commitment and the periodic rebalancing of your portfolio to keep on track. Investing in foreign stock can enhance your portfolio’s value. But investing is a personal decision — goals can be different from one person to another. When making important financial decisions that can affect you long term, consult with a financial advisor.
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