International investments are the securities that you purchase across international borders. Just like domestic investments, these may take a variety of forms, from government debt (bonds) to stocks and ETFs. And, just like domestic investments, the goal is to capitalize on the growth potential of your assets.
International investments are the investments we make in foreign companies and governments on foreign exchanges. For instance, these can include stocks, bonds, and ETFs, as well as riskier investments like currency options and futures.
By broadening your reach to other countries, you diversify your portfolio and balance out some of the risks of only investing domestically. However, as a result, you also assume some of the risks that come with international investments, such as changes in exchange rates, geopolitical events, and international interest rates.
What is International Investing?
Many financial experts advocate investing in international securities as a way to diversify your portfolio and mitigate domestic losses. However, that doesn’t mean these investments are without risk themselves.
There are two main types of international investments:
- Foreign Direct Investments, or FDIs, are physical purchases made within another country’s borders, typically by corporations. Examples of these investments include opening a factory or purchasing equipment.
- Foreign Indirect Investments, also known as Foreign Portfolio Investments or FPIs, are stakes purchased off a foreign country’s stock exchange. These often take the form of stocks, bonds, or ETFs.
However, for the purposes of this article, we’re going to focus on the latter, as individuals are more likely to invest in FPIs.
Types of International Investments
Investing in foreign securities is similar to putting your money in your home country’s market. Depending on the country, you usually have access to the same options offered on domestic exchanges. Seasoned investors may also take a gamble on qualified investments, such as international currencies and options.
Government bonds and notes are one common way to get involved in international investments. For instance, countries may issue debt to avoid raising taxes or to raise funds for new projects. And these investments come with differing interest rates and maturities, depending on where you invest.
Q.ai says: If you’re looking to invest in international fixed income securities, it’s a good idea to gauge the government’s risk first. In fact, there are plenty of free online tools that that calculate each country’s credit market rating, such as this one from Trading Economics.
Also, if you’re more interested in foreign equities – who isn’t? – there is a long list of international indexes to help you get started. For instance, all-country indexes compile stocks from around the world to give you a comprehensive list of options. Alternatively, you can go with an index that caters to specific market classifications.
Before you get started investing across borders, it’s important to understand the stability of not only the business, but the country of origin. Many financial institutions, such as the S&P 500 and MSCI, categorize a country’s economic and market risk one of three ways.
Developed markets have advanced economies and offer lower-risk investment opportunities. Typically, this means the country has an established financial infrastructure and a network of corporate marketplaces.
Emerging and frontier markets are usually calculated differently amongst the classifying institutions, which means some countries may receive two competing ratings. Typically, emerging and frontier markets are fledgling economies located within or surrounded by regions of geopolitical instability. However, they also offer huge growth potential to offset the risk.
This map from Global Finance magazine outlines their take on emerging and frontier market investment opportunities in 2019.
Why Should Investors Add Foreign Securities to Their Portfolio?
Though international investing can be risky, there are some significant benefits, as well.
First up is the innate diversification and lower correlation that comes with tossing your capital across the border. By adding foreign stocks, bonds, and ETFs to your portfolio, you spread your risk and mitigate your losses in the event of an economy-wide collapse. (March of 2020, anyone?)
It’s not just about mitigating your losses, either. If you don’t diversify across economies, you’re guaranteed to miss out on global market rallies when they occur. Just because the NYSE is down doesn’t mean the LSE (London Stock Exchange) is, too – and vice versa.
Additionally, many emerging and frontier markets offer greater potential for growth than developed economies. While they often come with enormous risks, their push to become a thriving economy means that early investors can see huge profits in return.
What are the Risks of International Investing?
All financial investments come with the assumption that there is some risk. However, in the case of international investing, there are some extra risks.
Q.ai Says: It’s essential to do your due diligence. You should familiarize yourself with:
- The issuing corporation or fund
- Underlying securities within a fund
- Foreign tax structures
- Political or military instability in the area
- Relevant economic regulations
For instance, many foreign markets have different – or no – regulations on the flow of information between corporations and stakeholders.
Another common risk is known as foreign exchange risk. This is the inevitability that currency exchange rates will fluctuate in the long-term. For investors with money in international markets, this may mean that even though your investment is doing well, the currency exchange rate is not. Some countries also enact “currency controls,” which may restrict your ability to move currency across borders.
There are also geopolitical risks to contend with. Times of civil unrest, violence, and military action are not only detrimental to the wellbeing of its citizens; they also tank the economy.
Venezuela, for example, made history in 2018 when it experienced sudden, unprecedented growth – and then crashed 95% in less than twelve months.
Ukraine is another – slightly more tempered – example of a country whose market has fluctuated with geopolitical instability due to political and international interference over the last two decades.
There are still others unique to international investing, such as:
- Higher investing costs
- Limited liquidity due to smaller trade volumes, fewer listings, time differences, or restrictions on foreign investments
- Changes in foreign interest rates
- Jurisdiction risk, including differences or changes in foreign market operations
- Limited or no access to legal remedies in cases of fraud or wrongdoing
The Cost to Invest Internationally
Your international investment costs will vary based on the securities you purchase as well as your choice of broker. In some cases, the country of origin may play a part in your final costs, too.
As with domestic investments, your investing fees will vary based on the securities you choose, as well as your broker or investment firm. Some institutions charge a flat rate per share or per trade, while others prefer to take a percentage of the trade value. A few use a combination of fee structures.
Once you’ve made the trade, you may also be subject to additional fees for safekeeping and management services. As with transaction fees, the price structure will vary depending on the institution in question. These fees can range from a few dollars per year to a significant percentage of your assets.
International investments come with their own maze of tax codes and legal forms regarding your capital gains. The first to consider is your home country; after all, just because your money is made outside the United States doesn’t mean that Uncle Sam doesn’t want his share.
Fortunately, the U.S. tax code offers a foreign tax credit to adventurous investors. This credit allows you to list some of your foreign taxes as a write-off on your capital gains income. Or, for those who prefer to itemize their tax returns, you can claim a full deduction on any “qualified foreign taxes.”
When it comes to countries outside the United States, each one has different tax laws – and it’s up to the investor to do their due diligence on paying up. Some may impose no capital gains taxes at all or waive the cost for foreigners. Others may require non-resident investors to pay up to 25% (or more) on any profits.
How to Get Started with International Investments
There are a number of ways to go about adding foreign investments to your portfolio, each with its own benefits and risks.
One of the most common ways is to purchase an ADR, or American Depositary Receipt. U.S. brokers offer these as a way to purchase foreign companies that trade in U.S. markets. These receipts are equal in value to the number of shares listed.
2. U.S. Registered Funds
U.S.-Registered Mutual Funds and ETFs are another popular way to gain international exposure on U.S. soil. These funds strive to provide diversification while staying subject to U.S. regulations, which gives investors more control over their investment. U.S.-Registered funds may invest in a combination of foreign and domestic companies, companies solely outside the U.S., or in particular regions, such as Europe, Africa, or Asia.
3. Companies on U.S. Exchanges
Some foreign companies trade directly on U.S. stock exchanges. The benefit of this practice is that these companies are subject to many of the same SEC regulations as domestic stocks, which limits their risk. Plus, investors can purchase these stocks from a licensed U.S. broker.
4. Foreign Markets
This is the most obvious method to trade in foreign investments – and one of the riskiest. Foreign companies trading in their respective domestic markets are not required to file any reports with the SEC, which means these investments are subject to the whimsy of local regulations and the company in question.
To get started in foreign markets, you can invest with a U.S. broker who trades in foreign securities or go through a foreign broker. (If you choose the latter, be sure to do plenty of research on both the investment and your broker!)
Looking for a hands-free approach to investing? Download Q.ai and let AI manage your money with institutional-grade, AI-powered investment kits – totally commission-free.