Knowing how to invest in foreign stocks is perhaps one of the best ways for U.S.-based investors to diversify their portfolios. Foreign stocks are a vital part of any well-diversified investment portfolio due to their growth potential. In addition, venturing into overseas stocks can lead to better returns and lower volatility.
Thankfully, there are a number of ways that you can add international stocks to your portfolio, depending on your investing needs.
Let’s dive right in with all the things you will need to know about investing in foreign stocks, including the best brokers for stock trading internationally.
What are foreign stocks?
A foreign stock is a stock that is issued by a company based outside the United States. Foreign stocks may be listed on several different stock markets around the globe, including in the United States in the form of American Depositary Receipts (ADRs).
Global shares, including international and U.S. shares, are tracked by indexes such as the S&P Global 1200 and the MSCI World Index.
How to Invest in Foreign Stocks
- American depositary receipts (ADRs)
If you are considering investing in foreign stock markets, one of the best ways to do that is to buy American depositary receipts. ADRs refers to stocks that trade on U.S. stocks markets, but represent shares in an overseas company.
This means they offer U.S. investors an easier way to invest in potentially foreign corporations. ADRs are typically listed on major U.S. stock markets such as the Nasdaq, or in the over-the-counter (OTC) markets. Alibaba ($BABA) is a popular ADR.
- ETFs and mutual funds
Another great way of investing in international stocks is through U.S.-registered mutual funds or exchange-traded-funds (ETFs) that hold baskets of overseas stocks. The inherent diversification benefits of these funds relieve investors of the burdensome task of selecting individual stocks.
U.S.-registered ETFS and mutual funds also shield you from some potential costs and risks associated with investing in foreign markets. In addition, these types of index funds are readily available, with some focusing on a specific country or a region while others track developed, frontier or emerging markets.
- c) Global depositary receipts (GDRs)
You can also buy foreign stocks through global depositary receipts, or GDRs. Unlike ADRs, GDRs are deposited with foreign banks. GDRs are available to investors worldwide, but they are mostly used by stock traders based in European countries. The stocks on deposit are usually located in Luxembourg or Brussels. GDRs are also listed on major U.S. stock exchanges.
Where a stock is only available on a foreign stock market, U.S. investors need to open an account with a brokerage firm to buy the stock.
A number of U.S. brokerage firms allow investors to trade foreign stocks. Some of the best brokers for international stock trading include:
- Fidelity Investments
- Charles Schwab
If you are interested in non-U.S. stocks, you might consider opening an account for foreign markets through them. Although you can still open an account with a brokerage firm in that country to buy the stock, it is best to avoid relying on non-U.S. brokers as they are not regulated by our state agencies.
The charges: The rates differ between brokerage firms, with some brokers charging an absolute amount rather than a percentage.
Things you need to ask yourself before investing in foreign stocks:
- What are the risks involved with foreign stocks?
- Will I get be getting accurate and timely information about the value of my foreign stock?
- How will the foreign country’s currency and the level of its exchange rate versus the dollar affect the value of my stock in that nation?
- How will the geopolitical events and economic conditions that affect the country where you intend to buy stocks impact your portfolio?
How Foreign Stocks Add Diversification
The premise for putting money in overseas stocks is typically driven by the diversification that the stocks offer to U.S.-based investors. While the U.S. may seem like the center of the universe, the global economy is very big. As a matter of fact, half of the world’s market cap is held by companies that are located outside the U.S.
Therefore, putting your money in U.S. stocks and foreign stocks provides diversification in not just the American economy, but also the global economy. What’s more, foreign stocks can help minimize volatility in your portfolio, thus protecting it against risks specific to any specific region.
You are also likely to benefit from the exposure to faster-growing regional of the global economy.
How Foreign Stocks are Taxed
Many investors are quite reasonably bemused by the tax treatment of their foreign stock holdings. As with any investment, there are a number of taxes involved when buying foreign stocks, particularly dividend-paying stocks.
From the perspective of the U.S. Internal Revenue Service (IRS), overseas stocks are just like any other capital assets you may purchase or sell.
That means you will have to pay tax in the same manner as if you had taken a profit on a U.S. stock when you dispose your foreign stock at a gain. This holds true whether you sell American depository receipts or you sell actual shares of the overseas equity.
Make sure you understand the tax implications both in the U.S. and overseas of your investment plan. You also need to know how you will pay for foreign stocks and receive funds in your brokerage account.
International diversification can boost your portfolio. However, it is important that investors be careful to avoid overselling and be realistic about what they can and cannot achieve with that diversification.
That is because non-U.S. stocks tend to be highly correlated with U.S. stocks during major market downturns, meaning the pros of global diversification can disappear when investors need them most. However, this does not mean you should not invest in foreign stocks.
Most financial advisors and experts recommend allocating 5% to 10% of your portfolio to foreign stocks if you are a conservative investor, and up to a maximum of 25% if you are an aggressive investor.