Investors who want to increase the diversification and total return of their portfolios are often advised to get into international assets. Many hesitate to take that advice.
There are, in fact, three big risks that investors add when they enter international investing. Knowing what they are and how you can mitigate those risks may help you decide if going global is worth the risk and potential rewards.
Key Takeaways
- Expenses on foreign transactions tend to be substantially higher.
- Currency volatility is an additional layer of risk in making foreign transactions.
- Liquidity can be a problem, especially when investing in emerging economies.
1. Higher Transaction Costs
The biggest barrierto investing in international markets is the added transaction cost. Yes, we live in a relatively globalized and connected world, but transaction costs still vary greatly depending on which foreign market you are investing in. Brokerage commissions in international markets are almost always higher than U.S. rates.
On top of the higher brokerage commissions, there can be additional charges specific to the local market. These can include stamp duties, levies, taxes, clearing fees, and exchange fees.
As an example, here is a general breakdown of what a single purchase of stock in Hong Kong by a U.S. investor could look like on a per-trade basis:
| Fee Type | Fee |
| Brokerage Commission | HK$299 |
| Stamp Duty | 0.13% |
| Trading Fees | 0.00565% |
| Transaction Levy | 0.0027% |
| TOTAL | HK$299 + 0.138% |
That's about $38.28 U.S. in fees per trade, based on the exchange rate on July 20, 2023.
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. This 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.
Minimizing Expenses
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.S. banks. They represent a foreign company's stock but trade as a U.S. stock, eliminating the foreign exchange fees.
ADRs are sold in U.S. dollars. And that makes their investors vulnerable to currency price fluctuations. That is, if you buy an ADR in a German company, and the U.S. dollar falls in value against the euro, the value of the ADR will drop correspondingly. Of course, it works both ways, but the risk is there.
2. Currency Volatility
When investing directly in a foreign market (and not through ADRs), you first have to exchange your U.S. dollars into a foreign currency at the current exchange rate.
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.
3. Liquidity Risks
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.
What Are Other Risks of International Investing?
According to the Securities and Exchange Commission, these are other risks and hassles associated with international investing:
- International investors may have difficulties accessing information on companies outside the U.S. (which may not be available in English).
- Working with a foreign broker or investment adviser may be a challenge since they may not be registered with the SEC and may not provide the same protections as brokers subject to the laws of the U.S.
- Securities markets can experience dramatic changes in value.
- Political, economic, and social events and how they influence markets abroad can be difficult to understand for investors.
- It can be difficult to find legal remedies outside the U.S.
- Foreign markets may operate differently than in the U.S.
How Can I Invest Internationally?
The Securities and Exchange Commission recommends the following stocks and funds to get international exposure as an investor:
- American depositary receipts
- U.S.-registered mutual funds
- U.S.-registered exchange-traded funds
- U.S.-traded foreign stocks.
How Can I Be Protected As an International Investor?
There are four mechanisms offered in place to protect investors:
- Investment legislation
- Investment contracts
- Bilateral investment treaties
- Multilateral investment treaties.
The Bottom Line
Investing internationally provides diversification and potential for growth, especially in emerging markets, but it comes with a set of risks. Among them, the main ones are the higher costs, the changes and fluctuations in currency exchange rates, and the different levels of liquidity in markets outside the U.S.
Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy.
Stock Exchange of Hong Kong (HKEX). "Transaction."
U.S. Securities and Exchange Commission. "Investor Bulletin: American Depositary Receipts."
Investor.gov, U.S. Securities and Exchange Commission. "International Investing."
Ashurst. "International Investment Protection."
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