In the past, investing in foreign securities was difficult. Today, it’s much easier because trading is digital and nearly instantaneous. Many brokerage firms let customers invest directly in foreign stocks and bonds, and nearly every firm offers foreign exposure through products like mutual funds and ETFs. No matter how you access them, foreign securities come with their own benefits and risks.
A major benefit of foreign investing is diversification. Diversification means spreading your money across different securities, industries, and regions so that one poor-performing area doesn’t overwhelm your entire portfolio. For example, if you owned only one stock and that company went bankrupt, you could lose your entire investment. Holding a mix of investments helps reduce that kind of concentrated risk.
In 2018, the energy sector (natural gas, oil, etc.) was the worst-performing sector, down more than 20% by the end of the year. If all of your money was invested in energy stocks, you would’ve lost a considerable amount. Meanwhile, the health sector (pharmaceuticals, medical technology, etc.) was up over 4% for the year (2018 wasn’t a great year overall; the S&P 500 was down over 6%). If you had some money in health stocks, gains there could help offset losses in energy. That’s diversification in action.
Foreign securities can add another layer of diversification. There have been many periods when domestic investments underperformed foreign investments. If the U.S. economy is in a recession, losses in U.S. holdings could be partially offset by exposure to foreign markets.
Depending on the country and the investment, foreign investing can also introduce additional risks. Foreign investments from countries with large, stable economies (like Japan or Germany) are generally considered among the safer forms of foreign investing. Investments tied to smaller or less stable countries can carry much more risk. Investments in companies or organizations from smaller, but growing, foreign economies are referred to as emerging markets.
Countries like Mexico, Thailand, and South Africa are considered emerging markets. While these countries haven’t historically been major players in the global economy, their economies are growing and gaining momentum. Investments in emerging markets can involve substantial risk because some of these countries face:
For example, Venezuela has a history of nationalizing businesses, meaning the government takes over a private company and claims it as a public good. If you owned stock in a foreign company and it was nationalized, you could lose a large amount of money and/or opportunity. You were the owner, but now the foreign government is. This can be a risk when investing in emerging markets.
Even with the downside risk, emerging markets can offer significant profit potential. If investors can tolerate the volatility that often comes with emerging market investments, there’s a history of strong returns in this area. Also, smaller economies have more room for growth, which can create more opportunities for profits.
Another major risk in foreign investing is currency risk. To invest directly in foreign companies and/or organizations, you typically have to convert currency. For example, investing directly in a Japanese company requires converting U.S. Dollars into Japanese Yen. At the time of conversion, the exchange rate can work for or against you. You’ve probably heard currencies described as “weak” or “strong.” Neither is universally “good” or “bad,” but each has consequences for investors.
A weak currency can be beneficial or detrimental, depending on the situation. A weak domestic currency works against an investor when buying foreign investments because it buys less of the foreign currency. Here’s a real-world example:
| Date | $1 US Dollar buys |
|---|---|
| June 2015 | 125 Japanese yen |
| November 2019 | 110 Japanese yen |
From June 2015 to November 2019, the U.S. Dollar weakened against the Yen. In other words, one U.S. Dollar bought fewer Yen in 2019 than it did in 2015. When this happens, it becomes more expensive (in U.S. Dollars) to buy Japanese investments.
Using these exchange rates, assume a share of a Japanese company costs 15,000 yen. Here’s how the U.S. Dollar price changes when the only thing that changes is the exchange rate:
| Date | Cost of ¥15,000 in USD |
|---|---|
| June 2015 | $120 per share |
| November 2019 | $136 per share |
Even though the investment still costs ¥15,000, it costs more in U.S. Dollars in 2019 because the U.S. Dollar is weaker. This is an example of currency (exchange rate) risk, which occurs when a currency conversion negatively affects an investment. Here’s the math behind the numbers above:
June 2015
November 2019
A weak U.S. Dollar works against American investors when purchasing a foreign investment. However, it works in their favor when selling a foreign investment and converting back to U.S. Dollars. If the investor sells the ¥15,000 Japanese investment, they would net $136 per share in November 2019, compared with $120 per share in June 2015.
A weak currency leads to different outcomes depending on whether you’re converting into or out of the foreign currency:
Weak domestic currency
A strong currency can also be beneficial or detrimental, depending on the situation. From November 2011 to November 2019, the U.S. Dollar strengthened against the Japanese Yen:
| Date | $1 US Dollar buys |
|---|---|
| November 2011 | 75 Japanese yen |
| November 2019 | 110 Japanese yen |
When the U.S. Dollar buys more Yen, it’s less expensive (in U.S. Dollars) to make a foreign investment. Converting Dollars to Yen gives you more Yen, which means you can buy more of the Japanese investment for the same number of Dollars.
| Date | Cost of ¥15,000 in USD |
|---|---|
| November 2011 | $200 per share |
| November 2019 | $136 per share |
In November 2019, a ¥15,000 investment cost $136 per share, which is much cheaper than the $200 per share cost for the same ¥15,000 in November 2011. A strong currency is favorable when buying foreign investments. Here’s the math behind the numbers above:
November 2011
November 2019
A strong currency also has a downside. If you sell a foreign investment while your domestic currency is strong, you receive fewer domestic currency units when you convert back. Selling a ¥15,000 investment netted $200 per share in November 2011, versus $136 per share eight years later in November 2019. This is another example of currency exchange risk.
A strong currency also produces different outcomes depending on the direction of conversion:
Strong domestic currency
Here’s a video that breaks down foreign currency risk further:
Series 7 test questions may involve foreign investments and currency strength. Foreign investments can improve diversification, but they also add complexity because returns can be affected by currency conversions. Depending on the exchange rates involved, currency movement can increase or decrease an investor’s overall return.
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