The Risks of Investing Abroad
Mutual funds are an excellent way to add international exposure to your investment portfolio. Individual stock picking is difficult enough when you’re only dealing with domestic equities. Analyzing foreign companies adds another layer of complexity, as you have to deal with issues such as differences in accounting, language, customs, and currency. Consequently, outsourcing the management of the international portion of your portfolio to a mutual-fund manager who is well versed in a particular country or region is one way to go. International index funds are another excellent option.
No matter how you choose to invest, however, you need to be aware of the risks inherent in foreign securities. One is currency fluctuation. When you purchase non-dollar-denominated issues and then convert them back to greenbacks, exchange rates can have a large impact on how well you do. A weak dollar (or strong foreign currency) can make your investment worth more, as you receive more dollars when it’s converted. Conversely, a strong dollar (or weak foreign currency) brings in fewer greenbacks when converted. Some mutual funds hedge their currency exposure to avoid these fluctuations, so be sure to check the prospectus carefully. Of course, by avoiding volatility through currency hedging, you also miss out on the potential upside benefit of a weak dollar.
Unstable governments and geopolitical factors can also increase the risk aspect of foreign investments. Wars, abrupt changes in government policy with regard to business, and markets that aren’t as highly developed as those in the United States are all a part of this, and such risks are heightened emerging-market economies. It is also important to be aware of the market-cap size that a particular fund targets, as smaller firms can be even more susceptible to economic and political disturbances. Also, funds that invest in a specific region are typically riskier than those that diversify across a wide range of countries, as any event in that region (be it economic, political, or a natural disaster) will have a much larger impact on a concentrated portfolio.
Despite the risks, foreign investments are a vital part of any well-balanced portfolio. There is just too much growth and opportunity overseas to not take advantage of it. By staying broadly diversified and investing only a percentage of your total assets in foreign securities, you can take advantage of worldwide growth in today’s global economy without taking on excessive risk.