If you’re looking to diversify your investments against fluctuations in the American economy, then you may want to consider investing in foreign securities. This strategy assumes that by investing in more than one economy, individuals may be able to “level out” the expected fluctuations that inevitably occur both domestically and abroad. The ever expanding global marketplace has made the purchase of foreign investments much easier for today’s individual investor. Hence, the continued interest in the BRIC countries; Brazil, Russia, India, and China.
Assessing the Risks
When most people think of purchasing domestic securities, they typically consider any potential risk at least to be familiar, while “foreign” issues often suggest something unfamiliar and, therefore, inherently more risky. However, splitting an equity portfolio between domestic and foreign securities may be a smart way for investors to help reduce risk. One country’s economy may be expanding while another’s is contracting, which can mean that when prices are declining at home, they may be rising elsewhere. Of course, investments in foreign securities can involve additional political and economic risks, particularly with respect to currency fluctuations.
Ironically, one of the factors that can contribute to foreign currency fluctuation is direct and indirect investment from outside the country. When investors see an economic opportunity and purchase securities, it can create a demand for the local currency that, in turn, can affect its value. Investors who rely on bond income for their living expenses may find this type of potential volatility unnerving.
Understanding the Benefits
Buying securities abroad currently has the potential to help protect against inflation at home. When inflation does run higher in the United States, interest rates will tend to rise, depressing issued bond and stock prices. During a period of high domestic inflation, the value of the dollar may decline because it would take more dollars to buy the same goods and services. The value of currencies of low inflation countries may increase in relation to the dollar because those currencies can be converted into a greater number of dollars. The reverse also holds true: When inflation runs high overseas, foreign stocks and bonds may convert into fewer dollars. As a result, U.S.-issued bonds and stocks may look more attractive.
Mutual funds are generally considered to be the most reasonable way for the casual or average individual investor to gain foreign exposure. Global bond funds invest in developed nations, but generally have more than 25% of their assets in domestic issues; international bond funds invest in developed countries, but U.S. bonds may make up a quarter of their holdings; emerging-market funds invest in developing countries and, as a result, may have greater volatility (as well as greater returns). There are also mutual funds that target select countries and specific regions of the world. Investors with only limited foreign equity exposure in their portfolios may want to consider sticking with global funds, since they can more easily shift funds to U.S. markets when foreign markets appear unattractive.
Whether looking homeward or abroad, investors should always remember that past performance is not a guarantee of future results; investment values will fluctuate in response to market conditions. As a result, when shares of particular investments are redeemed, they may be worth more or less than their original cost. A thorough review of each fund’s prospectus will provide you with greater insight into the fund’s objectives, risks, and assets under management—whether they’re in the U.S. or abroad.
Note: International securities have additional risks, such as currency exchange fluctuations, different accounting standards, governmental regulations, and economic conditions not present with domestic investments.