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Much has been written recently about
whether it makes sense to invest in international markets. Some
investors question the benefit of international diversification
because economic globalization has caused markets to move more closely
together, the world's economies are becoming more interrelated,
and dramatic changes in stock value in one market can spread quickly
to other markets. Yes, the correlation between markets has increased,
but you can still reduce your portfolio's volatility by adding some
international equities to your portfolio and potentially enhance
overall performance. If diversification has you adding bonds to
your stock holdings and small-cap stocks to a large-cap stock portfolio,
including overseas stocks derives the same benefit.
Stock market volatility is a major reason for investing globally.
All countries go through economic cycles but not at the same time.
Investing in different markets reduces the impact when one region
experiences a downturn. For example, Japan, had a great year in
1999, but has also produced some of the worst returns over the last
10 years. You don't know which markets will outperform, which ones
will stink, that's why diversification is so important. Ignore the
thousands of other possible global stock investments and you miss
out on some excellent opportunities for growth and performance.
Some interesting facts
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Companies outside the United States
now represent more than half of the world's total market value.
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There are more than twice as many
foreign companies (19,658) as U.S. companies (8,251) in which to
invest.
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Many of today's leading multinational
companies are based outside the U.S. (i.e., Nestlé, Toyota, and
Hong Kong Shanghai Bank).
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Between 1970 and 2000, the U.S. equity
market has never been the world's top performer and has ranked among
the top 3 only twice in the last 10 years.
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The world's largest food company is
not a U.S. company (Nestle SA-Switzerland).
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Burger King, Breyers Ice Cream, Dunkin
Donuts, and Dannon Yogurt are all foreign based companies (U.K.,
Netherlands, U.K., France, respectively).
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The leading mobile phone operator
in the world is Vodaphone Airtouch Plc (U.K.)
There are additional risks to investing in international
markets. Some of these risks are:
Political risk addresses the stability of the government, the
actions of the government, and the stability of the political climate.
Governments can change, take over companies, and can drastically change
policies and rules.
Currency risk is concerned with the value of the stocks local
currency as compared to the U.S. dollar. Foreign companies trade and
pay dividends in the currency of their local market. When you receive
dividends or sell your international investment, it's converted into
U.S. dollars. Depending on the exchange rate, it can translate into
more or fewer dollars.
Market risk concerns the reliability of reported corporate
information and the ease (or lack of) of trading shares. Accounting
practices may differ making comparisons difficult. For the U.S. based
investor, the marketplace has several options to invest internationally.
Mutual Funds - International investing
through mutual funds can reduce some of the risks.
Advantages:
- More diversification than most investors could achieve on their
own.
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Professional management - Because
international markets are have additional risks, mutual funds can
add value because the fund manager is familiar with international
markets and has the resources to research.
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Mutual funds will handle currency
conversions and pay any foreign taxes.
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Mutual funds that invest internationally
probably will have higher costs than funds that invest only in U.S.
stocks.
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Investment style risk - although the
funds prospectus mandates the percentages & limits of where and
what to invest in, the latitude can still allow for some wide variances
in style and strategy.
There are different kinds of mutual funds that invest in foreign
stocks.
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Global funds invest primarily
in foreign companies and developed markets but may also invest in
U.S. companies.
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International funds generally
limit their investments to companies outside the United States with
a variety of stocks from many countries. Because they're more broadly
diversified, global and international funds may be less volatile
than emerging market or single country funds.
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Regional or country funds invest
principally in companies located in a particular geographic region
or in a single country. This provides a way to focus on political
or economic conditions that may be favorable. However, they are
more volatile since they're less diversified than international
or global funds.
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Emerging market funds - These
funds generally invest in developing markets (i.e., Russia, South
Korea, Mexico) and many are in transition from government control
to a free market, or from agricultural to industrial. They are often
very volatile, but can sometimes offer the potential for great returns.
They also tend to have the lowest levels of correlation with American
stocks, which gives you the most effective diversification.
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International Bond Funds -
International bond funds primarily invest in debt securities issued
by foreign governments and corporations.
ADR's (American Depository Receipts)
An ADR is a registered security issued by a U.S. bank representing
shares of a foreign stock. ADR's trade on U.S. stock exchanges and
on the over the counter market. Companies traded through ADR's must
comply with U.S. General Accounting Practices. If you own an ADR,
you have the right to obtain the foreign stock it represents, but
U.S. investors usually find it more convenient to own the ADR. The
price of an ADR corresponds to the price of the foreign stock in its
home market, with some adjustments.
Advantages compared to owning foreign shares directly:
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When you buy and sell ADRs you are
trading in the U.S. market. Your trade will clear and settle in
U.S. dollars.
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The depositary bank will convert any
dividends or other cash payments into U.S. dollars before sending
them to you.
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The depositary bank may arrange to
vote your shares for you as you instruct.
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It may take a long time for you to
receive information from the company (such as shareholder meetings
and voting) because it must pass through an extra pair of hands.
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Depositary banks charge fees for their
services such as for converting foreign currency into U.S. dollars,
and usually will pass those expenses on to you.
IShares
IShares are index funds that trade like stocks. Shares are
available for both U.S. and international equity indexes. The key
difference between IShares and mutual fund index funds is that mutual
fund trades are executed at the end of the day (market close). IShares
trade throughout the day whenever the market is open. Stop and limit
orders can also be used.
U.S.-Traded Foreign Stocks. Although most foreign
stocks trade in the U.S. markets as ADRs, some foreign stocks trade
here in the same form as in their local market. International investing
can be more expensive than investing in U.S. companies. In smaller
markets, you may have to pay a premium to purchase shares of popular
companies. In some countries there may be unexpected taxes. Transaction
costs such as fees, broker's commissions, and taxes often are higher
than in U.S. markets. Mutual funds that invest abroad often have higher
fees and expenses than funds that invest in U.S. stocks, in part because
of the extra expense of trading in foreign markets.
Conclusion
Two reasons why you should invest internationally are:
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Diversification -- spreading
your investment risk among foreign companies and markets that are
different than the U.S. economy, and
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Growth -- taking advantage
of the potential for growth in some foreign economies, particularly
in emerging markets.
If you do decide to invest internationally:
Use dollar cost averaging - Investing a set amount of money
at regular intervals reduces the risk of buying shares at a market
high while ensuring that you will buy additional shares when the price
dips.
Seek a mix of fund - Diversify by selecting a variety of investment
styles and geographic regions.
Avoid chasing hot areas - Markets go in and out of vogue. By
the time you read or hear about a hot region, it may be about to cool
off.
Know what you own - Even if you have only invested in U.S.
companies, you already may have some international exposure in your
portfolio. Don't duplicate this.
Think long-term - Short-term volatility dissipates with time.
Minimize costs - Select mutual funds whose operational costs
are equal to or less than the average for similar international mutual
funds.
Go with experience - Select managers of mutual funds who have
a proven track record with the same fund (at least three years) and
the fund's performance is equal or better than its peers.
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