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Foreign Investing 101: What You Should Know Before Investing Your Dollars Abroad

Emerging markets have been the hot investment areas over the past few years. Investors have rushed to invest in the BRIC nations (Brazil, Russia, India, China). These countries have seen double digit growth rates as their economies have burst onto the national scene. Institutions and investors alike are dying to get a piece of this fast growing market. Although international investments do have a place in the portfolio of young investors; there are a few things that you need to watch out for.

Let’s take a look at factors to consider before investing in foreign assets.

The risks of foreign investing

Foreign taxes

Foreign capital gains can be subject to higher foreign taxes as well as U.S. taxes. Investors have to be careful to investigate any foreign stock, bond, or mutual fund for tax implications. Many foreign investments have special tax rates that can greatly reduce your investment return. There is no point in investing in a high yielding asset if the majority of your return will be eaten away by taxes.

Currency risk

Foreign investments are much more sensitive to currency fluctuations. If the value of a foreign currency drops against the U.S. Dollar, then the value of your stock investment would fall.

Conversely, a decrease in currency value can work for you. An increase in the price of a foreign currency against the U.S. Dollar will increase your investment’s value. A strong dollar is bad for foreign investing whereas a weak dollar benefits investors.

For example, if you bought 100 shares of Honda then the money that you paid to buy shares will be converted into the Japanese yen. Let’s say that the value of the Japanese yen has dropped against the dollar when you redeem your shares. The value of your investment in Honda will be worth less when your money is converted back into U.S. Dollars.

Scams and political instability

Many investors have been duped into investing in foreign assets by con men like Allan Stanford.

These tricksters often offer high yielding interest rates on bonds and certificates of deposits to overseas investors. Many overseas investments promise investment returns that they cannot deliver. Investors have little to no recourse if a company defaults on its payments. It can also be difficult to get clear information about many foreign investments. Even governmental securities have a high risk in many foreign countries due to political instability.

The safest way to invest in foreign assets

The easiest way to invest in foreign stocks is through American Depositary Receipts (ADR). ADRs are “dollar denominated negotiable certificates issued by U.S. banks that represent a certain number of shares of stock of a foreign company and are traded on a U.S. stock exchange.”

Basically they are American certificates that represent an ownership interest in a foreign stock. If you wanted to buy stock in a foreign company like Toyota Motor Corporation or BP, then you would do so by buying ADRs.

If you would like to invest in a number of different foreign stocks then a stock fund may be right for you. Foreign stock funds are a safe way of gaining access into foreign markets. Investors can also invest in foreign exchange traded funds (ETFs) such as the iShares MSCI Emerging Markets Index (EEM) which gives individuals broad exposure to emerging market assets.

What’s your favorite foreign investment?

Published or updated on September 23, 2010

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