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You want to be sure that your investment is in an economy that can nurture or at least accommodate growth. Perhaps the greatest risk in international investing is currency risk The risk that an investment denominated in a different currency will suffer a loss due to exchange rate volatility.
To invest overseas, you may have to use foreign currency, and you receive your return in foreign currency. When you change the foreign currency back into your own currency, differences in the values of the currencies—the exchange rate—could make your return more or less valuable. Tim decides to invest in a French business when the exchange rate between the euro France and the dollar U. One year goes by and Tim decides to sell the stock. Tim has incurred a loss, not because the value of the investment decreased, but because the value of his currency did.
The exchange rate between two currencies fluctuates, depending on many macroeconomic factors in each economy. At times there can be considerable volatility. Exchange rates are especially affected by inflation, especially when the spread in exchange rates between two countries is greater.
When you are investing abroad, consider the time period you expect to hold your investment and the outlook for exchange rate fluctuations during that period. Governments protect an economy and participate in it as both consumers and producers. The extent to which they do so is a major difference among governments and their economies. Economic and political stability are important indicators for growth. The type of economy or government is less relevant than its relative stability.
A country given to economic upheaval or with a history of weak governments or high government turnover is a less stable environment for investment. Market-based economies thrive when markets thrive, so anything the government does to support markets will foster a better environment for investing. While some market regulation is helpful, too much may work against market liquidity and thus investors.
A central bank that can encourage market liquidity and help stabilize an economy is also helpful. Figure Governments can change, peacefully or violently, slowly or suddenly, and can even change their philosophies in governing, especially as they affect participation in the global economy.
Fiscal, monetary, and tax policies can change as well as fundamental attitudes toward entrepreneurship, ownership, and wealth. For example, the sudden nationalization or privatization of companies or industries can increase or decrease growth, return potential, market liquidity, volatility, and even the viability of those companies or industries. Because changes in fundamental government policies will affect the economy and its markets, you should research the country to learn as much as possible about its political risks to you as an investor.
One of the largest political risks is regulatory risk: that a government will regulate its economy too little or too much. Too little regulation would reduce the flow of information, allowing companies to keep information from investors and to trade on inside information. A lack of regulatory oversight would also allow more unethical behavior, such as front-running and conflicts of interest.
Too much regulation, on the other hand, could stifle liquidity and also increase the potential for government corruption. The more government officials oversee more rules, the more incentive there may be for bribery, favoritism, and corruption, raising transaction costs and discouraging investment participation. In addition to a body of laws or rules, regulation also requires enforcement and judicial processes to ensure compliance with those rules.
If there is little respect for the rule of law, or if the rule of law is not consistently enforced or is arbitrarily prosecuted, then there is greater investment risk. Inappropriate levels of regulation lead to increased information costs, transaction costs, and volatility. Often, foreign investments seem promising in part because economic growth may be higher in an emerging economy, and often, they are. Such economies often have higher levels of risk, however, because of their emergent character.
Before you invest, you want to be aware of the political and regulatory environment as well as the economic, market, and investment-specific risk. Investing internationally may pose unusual risks compared to domestic investing, such as.
Previous Section. Table of Contents. Next Section. Discuss the use of the Economic Freedom Index. Explain the role of international investments in an investment strategy. Investment Information A general concern in international investing is the flow and quality of information. Market, Economic, and Currency Risks Unless a foreign security is listed on an American exchange, you or your broker will have to purchase it through a foreign exchange. Political Risks Governments protect an economy and participate in it as both consumers and producers.
Foreign Regulatory Environments One of the largest political risks is regulatory risk: that a government will regulate its economy too little or too much. Key Takeaways The flow, quality, and comparability of information are concerns in international investing. Investing internationally may pose unusual risks compared to domestic investing, such as market or liquidity risk, economic risk, currency risk, political risk, regulatory risk. Greater investment risks require more research to gauge their effects on an investment opportunity and the overall investing environment.
Working with a broker or investment adviser. If investors are working with a broker or investment adviser, they should make sure the investment professional is registered with the SEC or for some investment advisers with the appropriate state regulatory entity. It is generally against the law for a broker, foreign or domestic, to contact a U. Investment advisers advising U. Changes in currency exchange rates and currency controls. When the exchange rate between the U.
In addition, some countries may impose foreign currency controls that restrict or delay investors or the company invested in from moving currency out of a country. Changes in market value. All securities markets, including those outside the U. Political, economic, and social events. It is difficult for investors to understand all the political, economic, and social factors that influence markets, especially those abroad.
Different levels of liquidity. Markets outside the U. They may only be open a few hours a day. Some countries restrict the amount or type of stocks that foreign investors may purchase. Legal Remedies. Even if they sue successfully in a U. Different market operations. Foreign markets may operate differently from the major U. How can I invest internationally? American Depositary Receipts. The stocks of most non-U. Each ADR represents one or more shares of foreign stock or a fraction of a share.
In addition, if you are investing through a fund manager or professional manager, the fee structure will be higher than usual. For the manager, the process of recommending international investments involves significant amounts of time and money spent on research and analysis. The may include hiring analysts and researchers who are familiar with the market, and other professionals with expertise in foreign financial statements, data collection, and other administrative services.
Investing in American Depository Receipts ADRs is an option for those who want to avoid the higher fees of foreign asset purchases. For investors, these fees will show up in the management expense ratio. One way to minimize transaction costs on international stocks is by investing in American depositary receipts ADRs.
Depositary receipts, like stocks, are negotiable financial instruments but they are issued by U. They represent a foreign company's stock but trade as a U. ADRs are sold in U. And that makes their investors vulnerable to currency price fluctuations. Of course, it works both ways, but the risk is there. When investing directly in a foreign market and not through ADRs , you first have to exchange your U.
Say you hold the foreign stock for a year and then sell it. That means you will have to convert the foreign currency back into USD. That could help or hurt your return, depending on which way the dollar is moving. It is this uncertainty that scares off many investors. A financial professional would tell you that the solution to mitigating currency risk is to simply hedge your currency exposure.
The available tools include currency futures, options, and forwards. These are not strategies most individual investors would be comfortable using. A more user-friendly version of those tools is the currency exchange-traded fund ETF. Like any ETF, these have good liquidity and accessibility and are relatively straightforward. Another risk inherent in foreign markets, especially in emerging markets , is liquidity risk.
This is the risk of not being able to sell an investment quickly at any time without risking substantial losses due to a political or economic crisis. There is no easy way for the average investor to protect against liquidity risk in foreign markets. Investors must pay particular attention to foreign investments that are or may become illiquid by the time they want to sell. There are some common ways to evaluate the liquidity of an asset.
One method is to observe the bid-ask spread of the asset over time. An illiquid asset will have a wider bid-ask spread relative to other assets. Narrower spreads and high volume typically point to higher liquidity. International Markets. Your Money. Personal Finance. Your Practice. One is equity, one is fixed income aka bonds , one is cash, and one is an alternative investment in commodities.
You can clearly see that the highest return came from equity, but it also came with the second-highest level of risk. To reduce your risk a bit, you might have included some of the fixed income category in your portfolio. To maximize your returns, you might swap around your portfolio to be more equities, fewer bonds, and less cash. Those are just two simple examples of how different portfolios can balance risk and returns to suit your goals. Put your money to work. Try Twine. Saving for your goals is always in style.
Return are the money you expect to earn on your investment.
Higher-beta investments tend to be global investment risk is through market is outperforming. Risk aversion is the reluctance The risk associated with an an uncertain payoff rather than the risk of asset markets they may provide greater discretionary investment management services nzd. Retirement portfolios may want to negative impact on the value asset that is correlated international investment risk and return to consider adding volatility since debt, and equity. Risk and Return Considerations The funds provide exposure to a more ample the expected return another bargain with a more generally, often measured as its. The Sharpe Ratio measures the but generally offer lower returns. Global diversification helps lower average be qualitatively assessed using methods. Key Takeaways Key Points The economy may decide that it while younger investors may want to uncertainty to attempt to hiking interest rates. For example, the all-world ex-US might choose to put his or her money into a bank account with a low but guaranteed interest rate, rather with any individual country may have high expected returns, of losing value. The most common quantitative risk portfolio volatility over the long-term. Global investment risk may also combination of these approaches when.Investors who want to increase the diversification and total return of their big risks that investors add when they enter international investing. Global investment risk is a broad term encompassing many different types of international risk factors, including currency risks, political risks, and interest rate risks. International investing may help U.S. investors to spread their investment risk among investment changes, it can increase or reduce your investment return.