As an investor, there are opportunities available in every country. Countless investment options offer a variety of benefits and help you diversify your investment portfolio. But investing in foreign stocks is not as straightforward as investing in your home country.
This article will cover more on the ups and downs of buying and selling foreign stocks. Knowing the pros and cons can help you when adjusting your portfolio.
Why should you buy international stocks?
Wise investors know not to keep all their money in one place. Diversification can present interesting opportunities when you add foreign stocks to your portfolio. Even though foreign stocks have higher volatility, they can also give greater returns on your investments. I’ve highlighted the pros and cons of investing in foreign stocks below.
Pros of investing in foreign stocks
Diversifying your investment portfolio is one of the best ways to protect it from risk and volatility. A greatly diversified portfolio protects you from many variables, including political turmoil, inflation, natural disasters, and more. In addition, you’ll have a better chance of weathering the storm if you don't tie investments to just one country or region.
Many regions of the planet are currently emerging markets. These markets have a high potential for great returns on your investment. But, of course, emerging markets are highly volatile and expose your investments to higher risk.
Cons of investing in foreign stocks
Unfortunately, buying foreign stock is not straightforward.
You are protected by The Securities and Exchange Commission (SEC) when investing with domestic companies. Foreign investments do not have the same protections. It can also be challenging to seek legal action against a foreign company or fund.
Most foreign markets are much smaller than the markets in the United States. This means many foreign markets have limited trading hours and lower trading volume. In addition, timezone differences can make it much harder to buy and sell your stock when you want to.
The U.S. has strict reporting information for its publicly traded companies. However, this is not the case in every foreign market. Delayed information could cause you to take losses or miss gains on foreign investment. It is therefore imperative to research your target market and avoid data issues.
The world is a chaotic place. War, recessions, and political turmoil can happen at any time. Staying ahead of the news is the only way to secure your investments. Even then, it can be incredibly difficult to understand the intricacies of global politics and its effect on your foreign investments.
Considerations before investing in international stocks
Investing in foreign markets is not as straightforward as buying stock on the NYSE. So before investing in any foreign project, you should research and understand the issues with buying foreign stock.
The world is hectic, and risks are associated with investing in any foreign country. Geopolitical developments, war, extreme weather, natural catastrophes, and other factors can drastically affect your investment. Other factors affecting your investment include strikes, inflation, currency fluctuations, elections, and shortages.
While it’s impossible to stay up to date on every news story, you need to consider all these factors before deciding to invest in a foreign market.
Investing in overseas stocks may cost more than domestic investment. This is because you have to consider the extra fees, transaction costs, currency conversions, and commissions before any investment or transaction.
Every stock market is volatile. Stocks that are soaring one day can come crashing down the next. Investing in new or unstable markets could mean higher volatility for your investment. While this could help you gain profits quickly, it could also mean disaster for your investment.
In general, developed markets tend to have less volatility. These markets are a better bet for investors who want to minimize their investment risk.
As of 2018, 26 countries are classified by the FTSE as developed markets. These countries are high income, have a high market capitalization, and are safe and secure compared to developing markets.
You also have to consider currency fluctuation when investing in a foreign market. As the value of a currency rises and falls, you’ll need to account for this while investing. This fluctuation can greatly impact your profits on investment.
How to invest in international stocks (6 ways)
I suggest diversifying your investment in international stocks. While it may be tempting to allocate 50% or more of your portfolio to international investments, this can be dangerous.
An ideal solution for most investors is 20-25% of your portfolio. You should also diversify by spreading the investment over several countries or regions with this percentage. Spreading your investment across Asia, Europe, and emerging markets is one of the best ways to allocate your funds.
Once you are ready to invest, it’s time to pick an investment strategy. Below are my top picks for how to buy foreign stock.
Mutual funds — Top pick
Global mutual funds are one of the easiest ways to invest in foreign markets. Mutual funds come in aggressive and conservative risk factors. You can also choose funds based on region or country. You also can manage your fund or let the investment run passively.
One drawback to international mutual funds is higher fees than their domestic counterparts. Still, mutual funds provide opportunistic long-term investments for many investors.
Exchange-traded funds (ETFs)
Exchange-traded funds (ETFs) are pooled investment security that is sold on a stock exchange. An international ETF helps novice and expert investors build a better, more diversified portfolio.
Unlike a mutual fund, the price of an ETF changes all day until the market closes.
Depending on the ETF, it may use several markets or geographical regions. Investment style, industry sector, and market capitalization also determine the ETF.
American depository receipts (ADRs)
Foreign companies use American depository receipts (ADRs) to raise capital in the United States. They can also help the company establish a presence in foreign markets.
Examples of ADRs available in the United States include Sony, Honda Motor Co, and Vodacom. These companies list and trade their shares the same way you trade any traditional U.S. stock.
ADRs' ease of trading makes them ideal for new investors looking to learn how to buy foreign stocks.
Global depository receipts (GDRs)
A global depository receipt (GDR) is like an ADR but focuses on shares in two or more global markets. Some banks issue stock shares in the home market and at least one more market. Often used for US and EU markets, GDRs have grown in popularity worldwide. They also represent an ideal way to invest in growing and emerging markets.
Foreign direct investing (open an account in a foreign country)
One of the best ways to buy stock in a foreign country is to open an account with a local broker in your target country. Although this method puts you in direct contact with a broker in your investment country, it has its downsides, too.
Using a foreign broker may have additional fees, tax issues, currency problems, and more. You can also experience technical support issues.
Many investors choose to open an account with a domestic broker in the target country. E*TRADE, Interactive Brokers, Fidelity, or Charles Schwab offer this option.
Multinational corporations (MNCs)
Finally, multinational corporations (MNCs) are another top pick for overseas investing. MNCs are domestic companies that sell a portion of overseas markets. Big companies like Coca-Cola, Disney, and Microsoft are ideal choices for this type of investment.
It’s easy to purchase stock in these companies, but this type of investment is not truly international either.
How much does it cost to invest in foreign stocks?
When investing overseas, you’ll need to consider the varying costs per transaction. Between fees and currency conversions, there is a chance to lose a significant part of your investment. So, you should always be aware of the following issues related to costs while investing in foreign stocks.
Taxes on dividends
You’ll have to pay taxes on your dividends if you own foreign stock. You may also have to pay U.S. federal taxes depending on the investment.
In general, the home country will tax you on your dividends. During tax season, the IRS will want you to claim your dividends. Luckily, you should be able to fully deduct the payment you have already made in your home country. This can avoid the double tax burden.
IRS Form 1116 allows tax filers to claim a foreign tax credit on their federal return.
Fees are a part of life, and international investments are no exception. However, they can vary greatly depending on the type of investment, country, transaction type, and more.
Some of the most common fees include custodial, transaction, management, brokerage, cash-payment, administration, and performance fees. Combined, these fees can take a hefty chunk of your investment and gains.
The value of every currency fluctuates nonstop, and you need to consider this when investing. Buying and selling stock during currency fluctuations plays a significant role in achieving profitable returns.
For example, a declining U.S. dollar can make your international investment more attractive. However, the reverse is also true. A strong U.S. dollar compared to the currency in your investment country can cause your investment to gain less than you may have hoped.
There is a lot to consider when investing in foreign stocks. The key takeaways are the pros and cons of these investments. Understanding these will help you make prudent choices when buying foreign stocks.
My top picks are a great way to get started. You’ll be investing in international stocks in no time if you follow this guide.