So much has been written of late about emerging foreign markets. Most of us realize that, by and large, these markets are located in the Far East. For example, Japan has been an economic powerhouse for quite a while now, followed in time by South Korea and China.
Recently, India has been making great economic strides to join its Eastern neighbors as an economic force to contend with. Still, we mustn’t lose site of the opportunities in Eastern Europe and Russia.
All of this attention to emerging foreign markets has not escaped investors. In fact, at the dawn of the 21st Century, over 10 percent of stocks owned by Americans were foreign stocks. Also, there are approximately 1,500 foreign companies currently registered with the U.S. Securities and Exchange Commission.
Americans like foreign investments, and foreign companies seem to like to operate in America.
Why We Are Investing in Foreign Stocks
The reasons are quite simple and understandable. First of all, American investors see the growth opportunities in emerging markets and want to get in on the action. They realize that countries like China and India haven’t even hit their stride yet and should be great long-term investment opportunities.
Secondly, diversification is driving this investment trend. Investors want to diversify beyond the American marketplace. They are spreading their risks into markets that are unique and different from the U.S. markets.
How to Make Foreign Investments
Actually, there are several ways:
- Buy mutual funds that specialize in foreign markets.
- Purchase U.S. traded foreign stocks.
- Purchase American Depositary Receipts (ADRs). These are shares of a foreign stock that are traded on a U.S. exchange — the shares are traded in dollars as opposed to being traded in the local currency, and the investor receives ADRs as opposed to shares in the underlying stock.
- Make a direct investment in a foreign market.
If you are interested in purchasing a foreign stock, the best advice that I can give you is to talk to your financial consultant and/or broker. Also, read “Investing: An Alternative Approach” In that article, I include some caveats about investing. Keep in mind that foreign stocks certainly have their risks.
Risks to Watch for When Making Foreign Investments
Here are some of my major concerns about foreign investments:
- Unless you are an expert investor or have some exceptional advisors, foreign investments have a history of underperforming U.S. stocks. For example, the S&P 500 had an average annual return of 17.05 percent for the period 1988 to 1998. During this same period, two major foreign-market index funds had a return of approximately 2 percent to 4 percent.
- Currency exchange risks are real and can have a negative impact on you when you want to convert your foreign investments to U.S. dollars. Of course, you could also make a profit on the conversion; it depends on the rate of exchange between the dollar and the currency in which your foreign investment is denominated.
- Foreign politics can negatively impact your investment. If there is any sort of political upheaval in the country where your foreign investment is based, you could suffer the economic consequences.
- Foreign stock may not always be as liquid as U.S. stock because foreign trading volumes are generally smaller than their U.S. counterparts.
- Foreign stocks mean foreign rules. That means the underlying accounting principles, legal remedies, ramifications and general market operations may seem quite archaic and difficult to understand and navigate to the unseasoned U.S. investor.
Emergence of Economic Powers
There’s no doubt about it — the world is changing, and changing rapidly. I would recommend that you read The World Is Flat, by Thomas L. Friedman. He talks about emerging economies and emerging economic giants. It certainly makes one consider investing in foreign stocks or bonds.
Another great book to read is Three Billion New Capitalists — The Great Shift of Wealth and Power to the East by Clyde Prestowitz. He describes “… the powerful trends whose convergence is rapidly shifting wealth and power to Asia …” Once again, this book causes one to seriously consider foreign investment.
Diversification Is the Key
No matter where you decide to put your dollars, diversification is still the way to go. It creates an added layer of security for the investor.
So, I would certainly consider foreign stocks, with the caveats that I expressed above. Just don’t over-invest in them. As always, consult your financial adviser and/or stockbroker, and be sure to do some basic “homework” on your investments. After all, it is your money.One good source of information is the Securities and Exchange Commission. The SEC actively looks to protect investors and, in this case, has an online pamphlet that discusses in greater detail some of the things I talk about. I think you’ll find the information extremely helpful.