According to the Securities and Exchange Commission, international investing continues to be a popular, and expanding, area for American investors. As early as 1985, the total capitalization, or market value, of foreign stocks surpassed the value of U.S. stocks for the first time.
Americans have a growing interest in foreign companies, and the number of these companies registered with the SEC has tripled over the last 15 years. There are two main reasons that investors in America have been flocking to international businesses: growth and diversification.
There is no doubt the American economy is experiencing a period of slow growth. In 2018, the U.S. gross domestic product, or GDP, grew at 2.6%. Compare the U.S. GDP figures to India and China, which experienced growth rates of 7.0% and 6.5% respectively in that same timeframe. It seems the real economic growth opportunities exist overseas, not here in America.
The other advantage international investing has to offer is diversification. By spreading money across both international and domestic companies, there is a greater opportunity to lower the overall risk of an investment portfolio. For example, if the U.S. economy starts to falter, the investor has a chance to leverage growth in a foreign economy. This allows the investor to maximize the overall return of their stock portfolio.
The stock market is a risky place to invest; that's why the potential rewards are high. But international investing carries with it another set of risks that investors should be aware of before buying stock in a foreign company. In fact, many of these risks are quite significant, and can make international investing problematic for many Americans.
Anyone that invests in an international company also assumes the risk associated with currency exchange rates. When purchasing the stock of foreign companies, the U.S dollar needs to be exchanged for the local currency. When selling the stock, that foreign currency needs to be converted back into American dollars.
When holding an international investment, the exchange rate of U.S dollars and the foreign currency can shift. This shifting can have an impact on the stock's return on investment.
For example, let's say John invests in a company that has experienced strong growth, and the currency of that country is strong compared to the United States. When this happens, John benefits from both the company's growth as well as the exchange rate. The opposite can also occur, either offsetting a potential gain or adding to a loss.
While some individuals complain about the policies of the U.S. government, there is no doubt the country itself is stable. The same cannot be said for many of the emerging economies across the globe. When investing in foreign companies, there are very real risks of government destabilization and the consequent negative impacts on the foreign corporations in that country.
The final risk associated with international investing has to do with the operation of foreign stock markets. Foreign companies that are not registered with the U.S. Securities and Exchange Commission may not report financial information on a frequent basis, often leaving investors wondering what is happening at the company.
There may also be different rules for the clearance and settlement of stock trades. The confirmation of trades, and the reporting of the transaction, may be much slower than in American markets. Finally, shares are often held safe with custodian banks and depositories. If the holding bank runs into financial difficulties, shares of stock held by that institution may not be protected.
Now that we've explained the benefits and the downside of international investing, were going to explain how to participate in these foreign markets. In this article, we're going to talk about the three most common ways: mutual funds, American Depository Receipts, and stocks traded on foreign markets.
Perhaps the easiest way to invest internationally is to purchase mutual funds. In fact, there are several types of foreign mutual funds from which to choose. Each fund type offers a slightly different opportunity, including:
Most of the international stocks traded in the United States are traded as American Depository Receipts, or ADRs. These stocks are issued by U.S. depository banks. Owning an ADR means the investor is entitled to hold the number of shares listed on the ADR. Many U.S. investors find it more convenient to hold these securities instead of directly holding foreign shares of stock.
One advantage of holding an ADR is the trade clears and settles in U.S dollars. The depository bank will convert stock dividends, and may also arrange for voting. The downside of owning an ADR is the depository bank acts like a middleman. This adds to the time it takes for a transaction to occur, as well as additional cost in the form of depository fees.
If the international company only trades on a foreign market, the help of a stock broker to process the transaction may be needed. Make sure the broker is registered with the SEC. As previously mentioned, stocks traded on foreign markets may not report information in the standardized format the SEC demands. That means any stock research conducted may be limited in terms of information that is freely available and accurate.
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