Investors strive to have a diversified portfolio, which for most investors should include some commitment to foreign securities. There are a number of ways to invest in foreign markets, the simplest being mutual funds or exchange-traded fundsthat invest in or track foreign markets. American depositary receipts are another option. [For more information about ADRs, see “Offbeat Offerings” in the August 2007 AAII Journal; available at AAII.com.]
Another avenue for investors to take part in international markets is to buy stocks directly from a particular country listed on a foreign exchange. These are known as foreign ordinaries.
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In this article
- How It Works
- How to Trade
- Investor Suitability
- Tax Consequences
- The Pros
- The Cons
- Additional Information
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How It Works
Foreign ordinaries can be traded in two ways: on the local market exchange or though a U.S. brokerage firm. If your trade is placed through the local market, it will occur when that specific market is open. If the stock is purchased through a U.S. brokerage firm, the trade is usually done during U.S. market trading hours and may involve a fee for the risk of trading the stock when the local market is closed.
When investing in foreign ordinaries, you are certain to face additional fees no matter the route you take to purchase the stock. Fees include, but are not limited to:
- The cost of accessing the local market (usually a fee to the local market agent),
- A currency conversion fee (you are typically buying the stock in U.S. dollars even though it is sold in foreign currency),
- A custody fee for a local institution holding the shares, and
- The costs to settle your trade in an expedited manner.
The standard U.S. settlement time is three days, whereas local markets may have longer settlement times.
In addition to a currency conversion fee, you should be aware of currency conversion rates and the risks and benefits. Brokers typically sell foreign ordinaries in dollars. If the dollar’s value is rising compared to the foreign currency, you stand to lose some of your gains when the stock is sold and currencies are exchanged back to the U.S. dollar. The opposite is also true. If the dollar’s value is falling relative to the foreign currency, you stand to gain from the conversion back to U.S. dollars.
How to Trade
You can invest directly in foreign stocks in a number of ways. The first is to ask your current broker if they have the ability to trade the stocks you are interested in purchasing. The firm will typically have an affiliation with a broker in another country that can carry out the transaction.
For example, U.S. brokerage firm Charles Schwab offers its customers real-time quotes on non-U.S. securities, currencies and exchanges as well as the ability to trade foreign ordinaries and ADRs. If your broker does not have this service, you could open a brokerage account in the country you wish to trade in—not always the easiest choice.
There are also a few services that offer direct stock trading on foreign markets. International Assets Holding Corporation (provides access to 8,000 ADRs and foreign ordinaries in over 20 countries. However, it is mostly geared toward institutional investors.
Investing in foreign securities can be a good way to diversify your holdings. While you can go about this in a number of ways, investing directly in the stock on a local exchange can be more complicated and risky than mutual funds or ETFs that invest in foreign markets. Investors must be willing to handle the ups and downs of the overseas markets, which can be more erratic than the U.S. market; although, these days the U.S. market is finding itself in a period of high uncertainty that is also affecting overseas markets.
Investing in foreign securities can be tricky when it comes to taxes. For some investments you may have to pay special taxes on gains and distributions that are imposed on foreign investors.
As with any atypical investment, you should always consult a tax professional to be sure you fully understand the tax implications.
Investing directly in foreign stocks is one way to increase the diversity of your portfolio in an effort to mitigate risk. However, depending on the company, the diversification benefits could be limited.
Investing in foreign stocks means currency must be converted. This can work in your favor if the dollar is falling relative to the foreign currency.
Access to Markets With High Growth Potential
By investing in securities on a local exchange you have the ability to tap into some emerging markets that may not be accessible otherwise. While this comes with a lot of risk, the potential for high returns exists.
Fees for investing directly in foreign stocks can add up quickly and eat into your profit (or add to a loss).
Limited Diversification Benefits
Due to the multi-national scope of many companies, investing in Toyota, for example, may not deliver the desired diversification effect. As companies do business in multiple countries (including the United States), their stock prices tend to be more and more correlated with stocks in the U.S. market. If you limit your selections to smaller companies, it would be difficult to achieve adequate diversification in the international markets, unless you supplement your individual stock holdings with a diversified international mutual fund or ETF holding.
If the dollar’s value rises compared to the foreign currency, you will lose some of your gains during currency conversion.
The NYSE is the largest and most liquid stock exchange in the world. Overseas stock exchanges are smaller and could be less liquid, making it harder to get in and out of positions quickly and at a desirable price. Time zone differences can also create problems when placing trades.
Availability of Information
Getting information about foreign companies might prove more difficult than getting information about U.S. firms. Countries have different rules and regulations regarding reporting and accounting techniques. Local markets may not require the detailed information that is required in the United States. Different accounting rules and principles might make comparing two companies difficult as well.
Euroland provides a database of financial events for major developed markets in Europe. It includes 25 stock markets and you can search the database by symbol, name, country of origin, or industry. The site also provides quotes, charts, news, a portfolio tracker and financial statements.
Site-by-Site is a portal for Web sites related to international markets and trading. An organized set of links to investment sites includes news, economic data, commentary, analysis, exchanges, central banks and more.
Fidelity provides free quotes on foreign ordinaries through its quote lookup service.
CIA World FactBook
The CIA World FactBook provides information on every government, country, and territory in the world. It provides a brief description of the country, its geography, the type of government, information on its communications, transportation, and military systems, any transnational issues, and a review of its economy. The economic review covers items such as GDP (gross domestic product), labor force, unemployment rate, budget, industries, imports and exports, currency, fiscal year, and debt.