Diversify your portfolio by investing internationally
Wednesday, 13 March 2019
The U.S. market has a long history of stable economic returns, but it isn't the only well performing market in the world--and investors can benefit from exposure to foreign markets as well.
Investing internationally allows you to diversify your portfolio, take advantage of strong markets elsewhere, and protect yourself against dips in the U.S. market. For instance, from 2000 through 2009, the Standard & Poor's 500 Index had a compound annual loss of 0.9%, while international asset class returns during the same period ranged from 1.2% to 12.8%, according to Marketwatch.
While international investing can be an important strategy for diversifying your investment portfolio, it also comes with a unique set of challenges.
Americans can invest directly in foreign companies or make international investments through mutual funds, exchange-traded funds, U.S.-traded foreign stocks or American depositary receipts (stocks that trade in the United States but represent shares held in a foreign company). Whatever method you choose to use in making international investments, it's important to be aware of the risks. Every investment carries risks, but when your investments are in foreign entities, there are a few more potential roadblocks.
Currency Exchange Risk
When you invest internationally, you must make trades and take dividends in the currency of the company's home country. The exchange rates between the U.S. dollar and various foreign currencies fluctuate constantly. This means that your investment will increase or decrease based not only on the performance of the company, but also on the performance of the local currency against the U.S. dollar (assuming you plan to convert your earnings back into dollars). If the U.S. dollar is strong against the other currency, you'll get fewer dollars in the exchange, but if the dollar is weak compared to the foreign currency, you'll get more dollars in the exchange, and your gains will increase.
In recent years, emerging markets have made headlines for outperforming developed markets: In 2017, emerging markets' gross domestic product (GDP) grew around 4.5 percent compared to 2.25 percent for developed markets, according to CNBC. However, things can change rapidly—in 2018, a currency crisis in Indonesia and a rise in inflation to 18 percent in Turkey showed that great gains come with great risk, reports Marketwatch.
Investing in both emerging and developed markets can be beneficial, but it's important to understand the market's environment and the risk involved. A country's political, economic and social environment can play a significant role in its investment markets. For example, emerging markets can offer significant returns on investment when things are going well. On the other hand, if a political regime is overthrown or an unstable currency experiences hyperinflation, the same investment could tank.
Events such as wars, terror attacks or big changes in economic policy can cause dramatic changes in market value. If you're not familiar with the environment in the country where you're investing, you may be caught off guard by such events that cause market swings.
Every country has its own regulatory requirements for publicly held companies. That means there are different time intervals for clearing and settling trades, different rules for custodian banks, trading volumes and liquidity. While investors in U.S. companies have the U.S. Securities and Exchange Commission regulating markets and requiring extensive disclosures and company information, not every country has similar oversight. That means when you're investing internationally, it may be difficult to find reliable company information. With different regulations governing foreign markets, you also may have to pay higher taxes on gains or higher transaction fees.
When your investments in overseas companies earn dividends or when you sell them for a gain, you must pay U.S. income tax on those earnings. However, the foreign country that is home to the company in which you're invested may also tax your earnings in that company. If that sounds like a dealbreaker, here's the good news: The IRS offers a foreign tax credit, allowing international investors to count some or all of the foreign taxes paid towards their U.S. tax bill. If you're investing internationally assets that are held in a trust, the trust will also be responsible for paying taxes on earnings both domestically and internationally.
With all these risks, international investing may seem unattractive—but it also offers global diversification and the opportunity for large gains when economies in other parts of the world are surging. With the help of advisors who are educated about various international markets, you can get help hedging the risks and capitalizing on the gains.
For more information about international investing and how to hedge risk, contact a BBVA Investments Financial Advisor.
The content provided is for informational purposes only. Neither BBVA USA, nor any of its affiliates, is providing legal, tax, or investment advice. You should consult your legal, tax, or financial advisor about your personal situation.
Opinions expressed are those of the author(s) and do not necessarily represent the opinions of BBVA USA or any of its affiliates. All accounts and credit are subject to approval, including credit approval
Securities and Investment products offered through BBVA Securities Inc., member FINRA and SIPC and an affiliate of BBVA USA. Insurance products are offered through BBVA Insurance Agency, Inc., an affiliate of BBVA USA.
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