In recent years, investing in foreign investments has become more popular with some investors. The following discusses some of the components involved with investing in foreign securities.
Some advantages of investing in foreign securities are:
- Foreign securities offer the potential for long-term growth and price appreciation.
- They, typically, have higher standard deviations than similar securities in the United States.
- Foreign securities (and foreign bonds) can be good way to diversify a portfolio.
- International investments reduce exposure to the U.S. dollar and can offer increased returns when the dollar is weak.
- Because income taxes are withheld on the income earned from an investment in a foreign security, the taxes withheld can be deducted on the investor’s U.S. income tax return.
The main disadvantages of investing in foreign securities are:
- Accounting standards in foreign countries differ from the standards in the United States, so earnings and profit are accounted for differently.
- Foreign companies do not have the same transparency and reporting requirements as U.S. companies.
- Fluctuations in the foreign currency, with U.S. currency, could change the total return on the investment for the worse.
- Different languages make reading reports difficult, unless an investor has experience with the specific language and market.
- Political risk can have a negative impact on foreign investments, for example:
- When Hugo Chavez was elected in Venezuela, he nationalized oil production.
- Greece, facing huge budget deficits and a risk of default on its debt, has a two-year bond yielding almost 43%
Foreign Equities
Typically, foreign equities must be purchased on an exchange in the country where the company is located. Some countries have restrictions on who can own and purchase stocks. Many nations require the use of a local broker to facilitate your purchase and sale of stock, often at a high commission, which can eat into your return. However, some foreign equities could be good investments.
American Depositary Receipts
American Depositary Receipts (ADRs) are another option for investing in foreign securities, rather than a direct investment in a foreign country. A foreign company that wants to offer its stock to a U.S. investor will ask a U.S. bank to issue a depositary receipt for that stock. The ADR allows the investor to purchase the foreign stock from a domestic source, using U.S. dollars, on an organized security exchange in the United States. This makes it a simple process for American investors to own foreign investments. Income from dividends and interest is paid to the investor in U.S. dollars, and foreign taxes are withheld from income received from the investment. Remember that an ADR still possesses currency risk and may only be available for large foreign companies.
Foreign Bonds
Foreign government and corporate debt can be purchased as investments similar to those in the United States. However, care must be taken to ensure that the bond does not carry too much risk. Foreign bonds are also denominated in foreign currency. Currently, in the emerging market BRIC countries (Brazil, Russia, India and China), only China’s government bonds are rated as investment grade at AA-. Europe, which is a developed market, has had a few countries facing default, with their bonds reduced to junk status or slightly above junk. As of August 2011, two-year Greek notes are offering a yield of almost 43% indicating significant risk in those bonds.
International Mutual Funds
International mutual funds offer an easy way to add international exposure to your portfolio; although, fees are, typically, higher than domestic mutual funds. Some of the larger, actively managed mutual funds have analysts located in the different countries where the funds invest. Even though the fund’s assets could be in foreign currencies, investors can invest with U.S. dollars on domestic exchanges.
Like American funds, be sure to check the fund’s prospectus before investing to make sure that you understand the fund’s objectives; the market or markets where the fund invests; the currencies and exchange rates, and the fees associated with the fund.
U.S. Companies
Often overlooked is the fact that many large U.S. companies have exposure to overseas markets where they generate a significant portion of their sales and earnings. These companies have potential for price appreciation and can help diversify a portfolio. Recently, with the monetary stimulus of quantitative easing, the U.S. dollar has weakened internationally. When the dollar weakens in value, American companies with overseas operations become more competitive. This has helped many companies generate additional revenue and profit. A few examples of large American companies with overseas exposure are The Coca-Cola Company (NYSE: KO), Caterpillar Inc. (NYSE: CAT), Deere & Company (NYSE: DE), The Boeing Company (NYSE: BA), PepsiCo, Inc. (NYSE:PEP), FedEx Corporation (NYSE: FDX), and United Parcel Service (NYSE: UPS).
What Does Henssler Financial Recommend?
As of August 2011, Henssler Financial recommends the following ADRs in our model portfolio of recommended stocks: Teva Pharmaceutical (NASDAQ: TEVA), Novartis AG (NYSE: NVS), British American Tobacco (NYSE: BTI), and Vodafone Group Plc (NYSE: VOD).
Our philosophy is that any money you need within 10 years should be invested in fixed-income securities, and any money that you will not need within 10 years should be invested in high-quality, individual common stocks or mutual funds that invest in common stocks. By holding fixed-income securities to provide for 10 years of liquidity needs, you should not need to sell stocks during a period of lower stock prices. For assets that should be in growth investments, we buy stocks or mutual funds that invest in stocks. For assets that should be in fixed investments, we buy bonds or certificates of deposit.
When we recommend individual common stocks, we only recommend companies that are least rated “A” by Value Line for financial strength, “A-” by Standard & Poor’s for quality, or “2” by Value Line for safety. If a foreign security meets our strict criteria, it may one day be part of our recommend portfolio.
We believe investors should Live Ready. That means fully understanding your investments regardless of their country of origin. For more information regarding this topic, please contact Henssler Financial at 770-429-9166, or experts@henssler.com.