If there is a basic lesson that every single investor has already learned is that diversification reduces the risk levels of a portfolio. However, most people consider only changes in their assets allocation, but forget that it’s possible to expand and diversify their portfolio geographically.
Buying international stocks can also help reduce volatility in a portfolio, protecting against risks specific to any particular region.
The Developed or the Emerging Markets?
Currently, the U.S. is responsible for half of the world’s stock market value. 27 out of the 50 most valuable brands in the planet are in the United States, a vigorous economy responsible for 1/3 of the world exportation.
The Wall Street Stock Forecaster recommends in their newsletter that Canadian investors should have 20% to 30% of their portfolios in the U.S. stocks.
But if you are curious about emerging economies and want to add more foreign stocks to your portfolio, you may want to know a little more about the emergent markets.
Chinese and Indian Consumers can boost long-term growth
Countries like China and India that were once closed to foreign investors, now present great growth potential for people who want to put their money abroad. These developing economies are on pace to compete with the U.S. as the world largest economies.
What makes large emerging countries such as China and India so attractive is that their economic growth is fundamentally linked to the rise of the middle class. According to Gabriela Santos of JPMorgan, right now only 12% of the Indian population belongs to the middle class.
However, it is expected that in the next decade, 80% of this population will become middle class. Hundreds of millions of people buying products such as beauty products and electronics.
Emerging markets offer investors a classic high risk and high return scenario.
Emerging nations, including countries such as Russia, India, Taiwan, and Brazil, account for 40 percent of world economic output, but only 12 percent of global market value, and as developing nations transition from an economy based on agriculture and commodities for industry and technology, the opportunity is expected to grow further.
The right balance
So, what’s the right balance? According to a study by Nationwide Financial, the optimal allocation to foreign stocks — when returns are maximized and portfolio volatility minimized — is 40%. Yet U.S. investors allocate about 22% to foreign stocks on average. In fact, most financial experts advise that 22% to 25% is recommended for aggressive investors, while those with a conservative profile should allocate only 5% to 10% of their assets to foreign stocks. Start slowly and keep growing over time, until you find the right balance for you.
How to Buy International Stocks Easily
Regardless the crisis the world might go through, big global companies get to keep stable and tend to have a significant appreciation over their stocks year after year.
Your most common options are purchasing foreign stocks directly from the home country’s security exchange. As well as investing in foreign stock mutual funds and buying foreign stocks listed on U.S. exchanges give investors exposure to foreign markets. You should analyze each investment opportunity and select the ones matching your portfolio goals and risk tolerance.
Mutual Funds or Exchange-Traded Funds
The easiest way to add international stocks to your portfolio is by investing in U.S. registered mutual funds or exchange-traded funds that track foreign markets.
These funds avoid potential risks and costs associated with investing in foreign markets. Since they are basically “baskets of securities”, their inherent diversification benefits relieve you of the onerous task of picking individual stocks.
Such types of index funds offer plenty of options for investing internationally — there are funds that are country-specific, regional or track different types of markets whether they are developed or emerging.
Check here Business Television Exchange Traded Funds episode, covering investment opportunities.
American Depositary Receipts
Other popular option these days is the ADR – American Depositary Receipt, a certificate issued by a bank to represent a specific number of shares in a foreign company. These certificates or receipts trade on American exchanges like regular stocks. As they trade in U.S. dollars, investors don’t have to deal with the problem of complex currency conversion. Typically, the price of an ADR stays close to the price of the foreign stock in its home market. They can be sponsored or unsponsored.
- Sponsored ADR is issued with the cooperation of the foreign company and normally grants foreign owners the same rights of domestic shareholders, such as voting.
- Unsponsored ADR typically trades over the counter, has less liquidity and shareholders may or may not have the right to vote.
Global Depositary Receipts
Another category of DR, a Global Depositary Receipt – GDR, represents a bank certificate issued in more than one country for shares in a foreign company. Shares are held by a foreign branch of an international bank and are traded as domestic shares, although they are offered for sale globally through the bank branches.
The term GDR is used around the world to designate any foreign company that trades on exchange outside its home country.
Direct International Investing is considered a riskier kind of investment that should be tried only by experienced and confident investors. Many foreign stock markets, especially those in emerging countries, present language barriers, lack of transparency, currency conversions, and more.
Furthermore, accurate information about overseas companies is not always available. Add to it tax rules and restrictions on transferring funds between nations and you have a combination that is not suit for most of the investors.
What is the best option?
Financial advisors agree that most investors could benefit from holding international investments in their portfolios. The best option, as always, depends on your investment objectives and risk tolerance. Generally, advisors recommend greater exposure to emerging market for younger investors and more developed market exposure for older investors.
Finally, finding the right option will demand some work and research, but once you expand your knowledge and explore the many options available, you’ll likely find the perfect balance for your portfolio.