Guido's Weekend Financial Wisdom: Should I Invest in International Stocks?

Posted Saturday, August 6, 2016 12:00 am

Evan R. Guido

In addition to investing in the stocks and bonds of companies located in the United States, you can invest in the securities of companies located outside this country. U.S. companies represent only about a third of the total market cap of the global stock market, so not investing internationally means that you are excluded from participating in much of the world's commerce.

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Reasons for investing internationally

Additional diversification

Though globalization has made all economies more interdependent and diversification alone can't guarantee a profit or protect against potential loss, other countries may be at a different stage in the business cycle than the U.S. economy. For example, they may recover more quickly or slowly from a recession.

Long-term growth in overseas markets

Some of the world's most rapidly growing economies are located around the globe, particularly in emerging markets with large and growing populations of potential consumers, or natural resources that are in demand worldwide.

Potential to take advantage of dollar weakness

Investing overseas can help you broaden your exposure to currencies other than the dollar. If the dollar weakens, having some investments denominated in foreign currencies may help offset the impact or enable you to take advantage of it.

The unique challenges of foreign investing

Potential for geopolitical risk

Though many emerging countries have become more politically and economically stable in recent years, others have not. The potential for political turmoil to have an impact on your investment can be high; companies can be nationalized, and bonds, even sovereign bonds issued by national governments, can be subject to default. Also, some currencies have experienced rapid inflation in the past, which also affects the value of investments denominated in those currencies.

Different accounting and reporting standards

Many foreign countries have accounting rules and regulations that differ greatly from U.S. standards.

The net earnings that a company declares in France may be calculated differently than net earnings reported by a U.S. company. Unless you have intimate knowledge of the accounting standards in each country, you may have difficulty intelligently analyzing individual companies. Also, reporting requirements may vary from country to country, so you may not be able to obtain the type of detailed information that is required by the SEC.

Difficulties in buying stocks on a foreign exchange

Some countries do not allow foreigners to purchase stock on their local stock exchanges. Other countries have severe restrictions and requirements on foreigners buying stocks within the country, such as requiring you to work with a broker located in that country.

Currency fluctuations

The return on any overseas investment involves two factors: the earnings of the investment itself, and the impact of currency exchange rates. You usually have to buy a foreign stock in that country's currency, and currency fluctuations may give you some difficulty. You can actually make an intelligent investment decision about a particular stock, but still lose money if you misjudge fluctuations between the U.S. dollar and the currency of the foreign country in which you have bought stock. You must make two correct decisions-- one about the particular foreign stock and the second about the currency fluctuation for the time period during which you plan to hold the stock.

It is not always easy to come up with an intelligent analysis on both decisions. Even if you invest in a mutual fund, you may still be exposed to the impact of currency fluctuations.

Some funds attempt to manage the impact of currency fluctuations on the fund's returns by using sophisticated hedging techniques. An unhedged fund will typically benefit from a weaker dollar and suffer when the dollar strengthens; hedging against currency fluctuations enables a fund manager to attempt to moderate such swings, though it may not eliminate them entirely. However, hedging against currency fluctuations also would likely mean a fund might underperform unhedged funds during periods of dollar weakness. It also reduces the extent to which you've diversified beyond the dollar.

Language barrier

If you choose to invest directly overseas, you'll need to know how you plan to deal with the language barrier. For example, annual reports and research reports on smaller foreign companies may not be published in English, and unless you can read the language, you may not have easy access to valuable investment information.

Ways to invest internationally

Individual securities

If you decide to invest in individual foreign stocks, one of the simplest ways to do so is through American Depositary Receipts (ADRs). These are trust receipts, issued by U.S. banks, that represent shares of foreign companies. The ADRs themselves are traded on the major stock exchanges in this country. You can purchase them with U.S. dollars, and they can be bought through a broker like any other stock.

Unfortunately, the supply of ADRs available usually includes only major foreign companies. The ADRs trade up or down each day, depending on how the foreign company does that day on the foreign stock exchange. Currency fluctuations may also play a part in how the ADR trades. Buying an ADR, though, is much easier than buying a foreign stock in a foreign country.

If you decide you want to invest in stocks not available through ADRs, your brokerage firm may have overseas offices that facilitate direct investment overseas. If you decide to go it alone and work directly with an overseas broker, be prepared to spend the time and effort necessary to deal with differences in time zones, language, and currency exchanges.

Investing in individual bonds issued either by foreign governments (known as sovereign debt) or foreign corporations can be challenging. Yields that are higher than U.S. Treasury bonds not only reflect the greater risk of default, but those higher yields may be offset or overwhelmed by any increases in the dollar's value. Also, liquidity could become an issue if you decide you want to sell your bond before it matures. Finally, researching a specific bond issue may prove even more difficult than researching a U.S. bond, and you will have the same issues with currency exchanges, transaction fees, and foreign laws that you would with individual stocks.

Mutual funds/exchange-traded funds

One of the easiest ways to invest internationally is through mutual funds or exchange-traded funds (ETFs). There are both index mutual funds and actively managed mutual funds, and some studies have shown that active management can be particularly valuable in researching international investments. Many of the larger mutual fund families have analysts (who may be foreign nationals) based overseas to provide research and stock picks to the manager back in this country. Also, though a fund's investments may be denominated in foreign currencies, you can invest in the fund itself with U.S. dollars.

Funds that invest overseas in either stocks or bonds include global funds, which invest worldwide, including in the U.S.; foreign or international funds, which invest exclusively outside the U.S.; regional funds; small-cap stock funds; emerging markets funds; and single-country funds.

As with any mutual fund or ETF, your analysis should carefully consider a fund's investment objectives, risks, charges, and expenses before investing. This information can be found in the prospectus available from the fund; read it carefully before investing. For example, funds that focus on a single country or emerging markets can be extremely volatile, and you should be aware of their potential for fluctuation in advance.

Foreign currency bank accounts and CDs

Some banks offer accounts and/or certificates of deposit denominated in foreign currencies.

Tax issues

You may owe foreign taxes on your overseas investment. If you have invested directly in an overseas security, any foreign taxes should be listed on your 1099 form. If you're investing through a mutual fund, the fund typically supplies information about the amount of foreign taxes paid per fund share.

That allows you to calculate how much you individually paid and claim the foreign tax credit on your federal income tax return, either as a line item on Form 1040 or by filing a separate Foreign Tax Credit form. The foreign tax credit is equal to the amount you paid in foreign taxes.

About Evan:

Evan heads a wealth management team at Baird in Sarasota, FL focused on retirement

planning. Evan entered the investment business in 2002. His team holds a series of

educational workshops in the community and is involved with numerous clubs and

charitable organizations in the community. Evan was born in St. Petersburg Florida,

attended the University of Alaska Anchorage and has 3 beautiful children with his wife

Brittany.

Evan Guido is a Financial Advisor with Robert W. Baird & Co. The content of this article was produced and provided by Broadridge Investor Communication Solutions, Inc. Copyright 2015. Baird does not offer tax or legal advice.