A December 2016 article on Marketwatch.com reported on a Morgan Stanley survey of investors that listed respondents’ top five financial worries for 2017. In order from greatest to least, these were:
- The breakup of the European Union;
- A recession in the United States;
- A “hard landing” for the Chinese markets and economy;
- War with Russia.
Because four of the five top worries for investors for 2017 involve international economic or political aspects, it seems like a good time to reconsider some basics of international investing, both the risks and the rewards.
In fact, it might be worth asking: Should you even risk international investing in the first place? After all, in addition to the usual market uncertainties, international investing also exposes you to currency fluctuation risk, often-unpredictable political risk, and sometimes–especially in emerging markets–liquidity risks. Given all that, shouldn’t you just keep your investments within the borders of the good old USA?
If you are interested in total return and reduced volatility, the surprising answer is, “Not necessarily.” Investment professionals and portfolio managers have known for years that adding an international component to your portfolio is a key to good diversification and reduction of overall portfolio volatility.
With that in mind, let’s take a look at some key risks of international investing. In a later article, we’ll review some of the potential rewards.
Risk #1: Transaction Costs. Investors are often surprised to learn that one of the biggest downsides of investing in foreign markets is the simple cost of doing the trades. In addition to brokerage commissions, international investment transactions can be subjected to stamp duties, trading fees, and transaction levies that can add significantly to costs, over and above the brokerage commission. Keeping transaction costs in check is a key to smart international investing.
Risk #2: Currency Risk. When you are purchasing your investments in one currency but their value is assessed in a different currency, it is always possible that unfavorable movements in currency valuation can have an adverse effect on your investment. For example, let’s say you bought shares in an Italian company when the Euro was strong, relative to the dollar. Next, let’s suppose that when you got ready to sell your stock, the Euro was very weak. Even though the price of the stock may have gone up in Euros, the number of dollars you would receive from the sale is reduced because of unfavorable currency fluctuation.
Risk #3: Liquidity Risks. Though emerging world markets can be quite enticing because of their rapid growth potential, the other side of the coin is that when markets are new and developing, they can be more susceptible to financial, political, or even military emergencies that can obstruct market liquidity. In other words, you might not be able to sell your investment quickly, if you decided you needed to.
These are some of the principal risks of investing internationally. Before you make global investing a part of your portfolio, you should consult with a qualified and trusted advisor who can help you devise a plan that takes these risks into account, in light of your individual financial goals and strategy.
In our next article, we’ll look at some reasons why risks like those discussed here should not necessarily scare investors away from the opportunities to be found outside the borders of the United States.