The Pros and Cons of Investing in Foreign Markets

Investing in foreign markets has never been
more accessible, especially for individual investors. But regardless of how highly
international investing is recommended by financial experts, many investors are
still skeptical when it comes to shipping their money overseas.

Many industry experts have come to the conclusion that the main reasons individuals fear international investment are the cultural barriers and foreign regulations. These are still issues that investors have to deal with at some point. However, holding at least a few foreign stocks helps with portfolio diversification. Moreover, it reduces volatility and raises the potential for financial growth.

Investing in foreign markets does not come free of risks. However, there are some ways it can turn into a profitable business.

What Are the Benefits of Foreign Investments?

The main rule of investing is finding the highest risk-adjusted capital return. Broadly speaking, an individual would seek to invest in a business where the profit is bigger than the overall risk taken.

This is why diversification has proven to be one of the best ways to enhance risk-adjusted returns. It is believed that a diversified portfolio should hold at least eight uncorrelated assets that are spread across multiple areas, both industry-wise and geography-wise. Uncorrelated assets are those assets that are in no way related and do not influence one another. This means that in the eventuality of one investment failing, it will not affect the entire portfolio. Investing in foreign countries adds to geographical diversification and improves stability.

Experts believe that one of the biggest mistakes investors make is to ignore the opportunities outside of their country. This includes small investors also, who don’t think they have portfolio sizable enough to include foreign investments. So index funds come to the aid of small investors by offering diversified foreign exposure.

Developing Countries Have Much to Gain

However, the advantages of foreign investment are not one-sided, as developing countries have a lot to gain from opening their gates to international investors. For example, they gain new job opportunities for locals and easier access to new technological advancements.

Consider the relationship between China and Israel, wherein Israel has become China’s third largest trading partner worldwide. Overall, both countries have had a lot to gain from this relationship.

The most important thing for a developing country is to understand the benefits a big investor such as China can bring. “Israel is far ahead of any other country … in recognizing the importance of Chinese investment and cultivating commercial ties inside China,” says Dorian Barak, private investor and CEO of Indigo Global.

Learn the Best Ways of Making International Investments

The key in foreign investments is finding the specific industries that one country is most focused on. For example, the Middle East is famous for its oil and gas industry. On the other hand, Chile is known for its rare minerals. There are multiple other industries that are constantly growing in all areas of the world. Therefore, investing in something that has a long history and growth potential in an area is more secure and lowers investment risks.

There are multiple ways of investing to diversify the financial portfolio. Exchange-traded funds (ETFs) are one of the most popular ways of investing in foreign markets. Along with mutual funds, ETFs add to portfolio diversity. That’s because they hold a basket of international stocks and bonds that investors can gain access to with just one transaction.

There are many different types of ETFs, depending on the area of the investments. For example, there are as international funds, regional funds, country funds, and sector funds.

International funds rely on investing broadly across multiple countries outside of the investors’ area of development. Regional funds focus on investing in specific regions, such as Asia or the Middle East. Country funds invest in specific countries, like Russia or Spain. Sector funds focus on investments in a particular sector, such as energy or gold, but spread across multiple countries that rely on that industry.

What Fund Type Is Best?

With all the available options for foreign investments, there comes the rising question of what fund type is the best. The answer depends on the objectives and risks an individual is willing to take.

Financial advisors usually recommend that younger investors choose funds that have a higher risk but offer the potential for bigger returns. Meanwhile, older investors should seek lower-risk funds that can provide them more stability. The general advice is that, no matter the choice, the funds should meet an investor’s objectives and risk appetite.

There are typically two ways investors can gain direct access to foreign stocks. One way is to open a global account with a broker in their country that provides the ability of buying foreign shares. Alternatively, they can open an account with a local broker from the targeted country that provides services for foreign investors.

The Risks of Investing in International Markets

All investments hold risks, and the foreign market is no exception. This is exactly why experts recommend creating a diversified portfolio. If, for example, the economy or currency of a country is starting to spiral downward due to poor governmental decisions, an individual’s other investments won’t be affected.

But just like domestic investments, foreign investments come with some risks. For example:

Currency Exchange Rate

Most foreign investments generate capital in their local currency. This means that investors need to convert these currencies at some point. With the exchange rate fluctuating over time, this can lead to substantial gains or losses.

Geopolitical Risks

Many developing countries face geopolitical risks, such as hostile neighbors or terrorism that can influence the country’s economy.

Economic Risks

While some countries have a stable economy, developing countries may face economic events that can seriously affect the companies that are operating within them. That’s because foreign companies often depend on their host country’s economy.

RELATED ARTICLE: STOCK MARKET INVESTING: THE BEST WAYS TO EDUCATE YOURSELF

Is Foreign Investing Worth the Risk?

With all the variables involving foreign markets, investors must ask themselves: Is international investing really worth the risk?

The answer depends on the area of interest. Some countries thrive in a particular industry and have remained global leaders throughout the years. For example, consider China in regard to technological development. China’s great strides in this area make technological investment decisions in China quite sound.

Other countries, such as Denmark, Sweden and Norway, have developed more toward the financial and healthcare industries. That makes these sectors more stable and easier to approach in those countries.

No matter the niche, experts recommend having at least 20% of your portfolio allocated toward international investments. Then you can increase the percentage over time, depending on market capitalization changes.