American investors have a number of ways to invest internationally. They can invest globally through mutual funds, exchange-traded funds, U.S.-traded foreign stocks, American depositary receipts, or direct investments in foreign companies. Although investing outside the United States can present opportunities, international investing comes with some disadvantages not found in the U.S. marketplace.
One big disadvantage of foreign investing is the currency exchange risk. Foreign companies trade and pay dividends in the currency of their home country. Changes in the exchange rate between that currency and the U.S. dollar can increase or reduce your return on the foreign investment when you sell it and convert your proceeds into dollars. If the dollar is weak against the foreign currency, your gains will increase because you will get more dollars when you exchange currencies. If the dollar is strong against the other currency, your gains will be smaller because you get fewer dollars in the currency exchange. Another currency-related risk is foreign currency controls that may limit the amount of money you can take out of the country.
Foreign investment markets can experience dramatic changes in market value, particularly when major changes occur in a country’s political, economic and social spheres. Events such as wars, revolutions, terror attacks or major economic policy changes in a country can send its markets into the abyss or into the stratosphere. A U.S. investor who is not familiar with the situation in the country where he invests can miss crucial signals of a big change coming. As a result, he may miss the chance to get out intact or get in to make a killing. Language barriers may also make it hard to assess another country’s situation.
Foreign investment markets may have characteristics that are different from the U.S. markets. An investor unfamiliar with how a country’s market operates can make costly mistakes. Foreign markets may have different time intervals for clearing and settling trades, different rules for custodian banks or depositaries, lower trading volumes and lack of liquidity. Foreign markets may not have the same type of extensive disclosure requirements for their public companies that prevail in U.S. markets, so it can be hard to find company information. You may face higher transaction costs and higher taxes on gains than exist in the U.S. If something goes wrong, you generally must rely on the regulations and legal remedies of the country where you are invested, not those of the U.S.
Why Invest Internationally?
With these disadvantages, why invest internationally? One advantage is global diversification. By investing in a range of countries and a range of companies within each country, you spread your investment risk around the world. A decline in one country can be offset by gains in another. U.S. and international markets sometimes move in opposite directions, so you might offset a U.S. decline with a foreign rise. If the U.S. and foreign market move in the same direction, the foreign market may experience a greater degree of change. Foreign markets may offer more opportunity for fast growth, particularly in the markets of emerging countries.
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