Financial Education Series

International Investing

Exploring the Benefits of Global Diversification

Investing internationally can provide exposure to different economies, industries, and growth opportunities that may not be available in your home market. This guide explores the benefits, risks, and strategies for incorporating international investments into a diversified portfolio.

Benefits of International Investing

Advantages of Global Diversification

Diversification Benefits

Different countries and regions often experience economic cycles that don't perfectly correlate with your home market. By investing globally, you can potentially reduce portfolio volatility while maintaining or enhancing returns.

Expanded Opportunity Set

The U.S. represents only about 60% of the global equity market capitalization. International markets provide access to:

Emerging economies with potentially higher growth rates

Industries with limited presence in the U.S. market

Companies with global leadership in specific sectors

Currency Exposure

Investing in foreign markets provides exposure to different currencies, which can:

Provide a hedge against domestic currency depreciation

Add an additional source of return (or risk)

Diversify purchasing power across different economies

Risks and Challenges

Special Considerations

Currency Risk

While currency exposure can be beneficial, it also introduces risk. Fluctuations in exchange rates can amplify or reduce your returns, sometimes significantly. This is a double-edged sword that can work for or against your investments independent of the underlying asset performance.

Political and Regulatory Risk

Different countries have varying levels of political stability, property rights protection, and regulatory frameworks. Changes in government policies, nationalization of industries, or restrictions on foreign investment can impact returns in ways that may be difficult to anticipate.

Market Structure Differences

International markets can vary significantly in terms of:

Liquidity and trading volumes

Corporate governance standards

Transparency and financial reporting requirements

Market maturity and investor protections

Tax Considerations

International investments can create tax complexities, including:

Foreign withholding taxes on dividends

Potential double taxation issues

Additional reporting requirements (FBAR, Form 8938, etc.)

Investment Approaches

Methods for Accessing International Markets

ETFs and Mutual Funds

The simplest and most accessible approach for most investors. Options include:

Broad international funds: Provide exposure to developed markets outside your home country

Emerging market funds: Focus on developing economies with higher growth potential and risk

Regional funds: Target specific geographic areas (Europe, Asia, Latin America)

Single-country funds: Concentrate on one specific market

American Depositary Receipts (ADRs)

Securities that represent shares in foreign companies but trade on U.S. exchanges in USD.

Advantages: Trade during U.S. market hours, settled in USD, meet U.S. disclosure requirements

Considerations: Limited selection of companies, may have lower liquidity than local shares

Direct Foreign Market Investing

Purchasing stocks directly on foreign exchanges through brokers that offer international trading.

Advantages: Access to full range of securities, potentially lower costs than ADRs

Challenges: Currency conversion, different trading hours, higher fees, tax complexity

Multinational Companies

Investing in domestic companies with significant international operations.

Advantages: Simplified approach, familiar securities, reduced direct currency risk

Limitations: Still correlated with domestic market, less pure exposure to foreign economies

Portfolio Allocation Strategies

How Much to Allocate Internationally

Market-Weight Approach

Allocating international investments based on global market capitalization (currently approximately 40% international, 60% U.S.). This approach provides exposure proportional to the actual global investment opportunity set.

Common Allocation Rules

Many financial advisors suggest allocating between 20-40% of an equity portfolio to international markets. The appropriate allocation depends on:

Your risk tolerance and comfort with foreign market volatility

Time horizon and investment goals

Your exposure to international economies through your career or business

Developed vs. Emerging Markets

Within your international allocation, consider the split between developed markets (Europe, Japan, Australia, etc.) and emerging markets (China, India, Brazil, etc.). A common approach is to allocate 75-80% to developed markets and 20-25% to emerging markets, roughly reflecting global market weights.

Currency Hedging Decisions

Some international funds hedge currency risk, while others leave the currency exposure unhedged:

Hedged: Reduces volatility from currency fluctuations but eliminates potential currency gains

Unhedged: Provides true currency diversification but can increase short-term volatility

Long-term investors often prefer unhedged exposure for greater diversification benefits.

International Investment Best Practices

1. Stay diversified within international holdings. Avoid concentrating too much in a single country or region. Broad index funds can provide efficient exposure to hundreds or thousands of companies across multiple markets.

2. Consider costs carefully. International investing can involve higher expense ratios, trading costs, and foreign taxes. Look for low-cost index funds or ETFs to minimize these expenses.

3. Take a long-term perspective. International markets can experience extended periods of underperformance followed by strong recoveries. Maintain your allocation through market cycles rather than chasing performance.

4. Rebalance periodically. As different markets perform differently, your allocation will drift over time. Regular rebalancing (annually or when allocations drift significantly) helps maintain your target risk level.

5. Consider tax location. If investing in taxable accounts, be mindful of where you hold international investments. Foreign tax credits may partially offset withholding taxes in taxable accounts but not in tax-advantaged accounts.

This article is for educational purposes only and updated as of June 2024. International investing involves special risks that domestic investing typically does not entail. Always consult with a qualified financial advisor before making significant changes to your investment strategy.