ARE YOU LOOKING for new investment opportunities? Have you considered investing in companies abroad? There could be interesting investment opportunities outside the United States. After all, roughly half of the global equity market is comprised of foreign equity.
Investing there might help raise your returns and diversify the risk exposure of your portfolio. However, before investing in assets overseas (and really any asset), it is important to understand the risk and return characteristics of the asset.
Investing overseas has the potential to increase the diversification of your portfolio. Diversification refers to spreading your money over different types of investments. This is an important concept because it has the potential to reduce the risk inherent in the portfolio. It’s the “don’t put your eggs all in one basket” approach, which could result in reduced risk and greater return.
Another reason to invest internationally involves the business cycle. Other countries might be at a different stage in the cycle than the U.S. These countries could be expanding or going into a recession just as the opposite is happening in the U.S.
There are overseas economies with long-term growth potential. Countries located in the emerging markets might have a growing consumer base or highly coveted natural resources that could impact their growth positively, increasing investment opportunities.
Essentially this is the difference between international developed market companies and emerging market companies. Emerging markets can grow rapidly and become industrialized. They may feature industries that are emerging and a growing middle class. Countries in the emerging market category include China, Brazil and India.
Developed markets are countries that are usually more politically stable, have regulations in place and more stable trade relationships. Their economics are established, and they have a stable infrastructure. Think England, Germany and Japan as examples of foreign developed markets.
These are some of the positive aspects to overseas investments. However, keep in mind that there are a few downsides. There might be political and economic risk. A country’s political structure, leadership and regulations might affect the government’s control of the economy.
There is also currency exchange risk. When an investment is denominated in a foreign currency, changes back into U.S. dollars could affect the value, and you could lose money on the exchange.
International investments are also volatile. Be prepared to hold them during market volatility. Rebalancing your portfolio is important. You will want to align your asset allocation back to your long-term strategy on a regular basis.
A final risk worth noting is that not all countries follow rigorous accounting principles. When you are looking at financial statements of overseas companies, there may not be an accurate picture of the company or the industry.
Considering the pluses and minuses, what is the potential risk versus return? For example, over the past 30 years foreign stocks have outperformed U.S. stocks at times. On the flip side, they have also underperformed U.S. stocks in certain years. Moral of the story: Domestic stocks do not always outperform international equities. Past performance is no guarantee of future performance either. The more risk you take, the greater the chance for more variable returns.
There are many factors to consider when deciding to invest internationally. Very often investors deal with something called “home” bias. We are comfortable with the U.S. because the companies are in our daily lives. As such, we tend to invest in domestic versus international assets.
To benefit from a professional in the area of international investing, you might want to consider purchasing a mutual fund or exchange-traded fund (ETF). Watch the expenses ratios. A small difference in expenses can add up to significant dollars over time. Lastly, it is a good idea to consult a CFP professional before making investment decisions.