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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 can "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 the modern day individual investor.
Assessing the Risks When most people think of purchasing domestic securities, they typically consider such 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 protect against inflation at home. When inflation runs high in the United States, interest rates 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. Buying individual foreign stocks or bonds is relatively complicated and expensive. Transaction costs and currency exchange fees can erode profits and may subject buyers to foreign withholding taxes. Similarly, these higher transaction costs generally translate into higher management fees for international and global mutual funds.There are a variety of mutual funds that invest abroad: 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; while 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 the United States markets when foreign markets appear unattractive.
It's a Small World After All In coming years, there likely will be less diversification potential from portfolios attempting to hedge domestic and foreign securities. As international agreements have begun to knock down trade barriers, the economic correlation between markets has begun to decrease.No matter what type of fund, investors should always remember that past performance is not a guarantee of future results, and they should be aware that investment returns and principal values of mutual funds will always fluctuate in response to market conditions. As a result, when shares 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 a greater insight into the fund's objectives, risks, and assets under management—whether they're in the U.S. or abroad.
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