Should You Own Foreign Stocks?
Is there a place in your portfolio for foreign stocks? International or global stocks may seem too exotic for some investors, but don’t dismiss them out-of-hand; our global economy offers plenty of opportunities.
Investors are attracted to foreign stocks by the chance to participate in growing economies other than the United States.
There are times when our economy is less than attractive or other economies, especially some of the emerging economies, show real opportunities.
Problems with Foreign Stocks
There is the problem of how to find, evaluate, and buy a foreign stock with confidence.
Fortunately, there are a number of foreign stocks that trade on U.S. stock exchanges just like American companies.
The investing community created American Depository Receipts (ADR) over 75 years ago to facilitate the trading of foreign stock. Here’s how they work.
A U.S. bank buys a large block of stock in a foreign company and bundles the shares for reissue on American stock exchanges. You can tell what's a foreign stock because they always have “ADR” after the name.
Foreign Stocks Trade on U.S. Markets
The stock trades in U.S. dollars, so you don’t have to do currency conversion to buy or sell.
However, there are some currency calculations involved in pricing the stock and when it is sold.
The price of the stock floats on supply and demand and usually follows the price of shares on its native exchange.
This is not a perfect arrangement and sometimes the U.S. price and the price on the native exchange don’t match closely.
If because of currency exchange rates, the original price of the stock is too low, the U.S. bank may bundle shares so that one share of the ADR may equal two or more shares of the stock.
Benefits of Owning Foreign Stocks
There are several benefits to owning foreign stocks, including:
- Globalization. Business happens all over the world and opportunities have followed. There are many opportunities in emerging markets such as Eastern Europe, as well as the Pacific Rim for investment.
- Diversification. There are times when the U.S. markets and economy may not offer the best alternatives for investment dollars. Looking abroad gives you other choices and spreads some of your risk over a wider geographic area and multiple economies.
- Uncommon returns. While there is risk involved (see below), foreign stocks may offer the chance to participate in extraordinary gains in rapidly growing economies.
Risks of Owning Foreign Stocks
Investing in foreign stocks carries the usual investment risks, plus some extras.
- Currency exchange. Even though you buy ADRs in U.S. dollars and receive U.S. dollars when you sell, there is still a currency risk. Currencies in some foreign countries may fluctuate more rapidly than in the U.S. As their currency becomes stronger or weaker relative to the U.S. dollar, your return may rise or fall.
- Political unrest. The political stability of some foreign countries is less than stable. Turmoil and even civil war is not unheard of and can have a negative impact on your investment.
- Inflation. Few countries, and certainly not the emerging markets, have the economic controls in place to deal with rising inflation. Inflation is one of the most dangerous conditions facing emerging markets and one they are least prepared to handle. Raging inflation can devastate your investment.
Owning foreign stocks is something most investors should consider at some point, despite the risks. Most financial professionals suggest that foreign stocks should not make up more than 10% of your portfolio – less if you are a conservative investor.