The volatility in the global economy means that some of the more established markets are not the safe havens they were once considered to be. With a bear market currently dominating trading, it can be more difficult to profit.
This means that foreign markets are becoming increasingly attractive not only as an alternative to generate a return, but also as a way to diversify a portfolio and protect against an ailing dollar.
However, when considering investing overseas, particularly in emerging economies to maximize gains, there are several factors that need to be taken into consideration.
Firstly, investing directly into foreign markets means that you will need access to top quality information in order to manage your portfolio. This can be more difficult to obtain and less reliable and regulation may be more lax than in the U.S. All of these factors can add an extra layer of risk to your investment.
Secondly, emerging economies are favorites for many investors as they offer access to commodities such as rubber, which are not widely available in the U.S. However, the political landscape and economic policies of the ruling governments can be far less stable leading to a rapid collapse, in the worst-case scenario.
This may sound very dramatic, but many investors who had a portion of their portfolio in Thailand were caught out when the baht nose-dived with very little warning.
Hedging Your Bets
Lastly, the interaction between the U.S. dollar and the currency of the country you are investing in will have an influence on your profits. A weaker dollar means you will receive more in return should you decide to sell your stock. For this reason, investing overseas in a market that has no direct link to the U.S. offers an opportunity to hedge your portfolio.
How you opt to invest in a foreign market will also have a bearing on your returns. For example, ETFs have seen massive growth in recent years and it is possible to opt for one that invests solely overseas. However, these kinds of ETFs will not perform in the same way as those based around the U.S. economy and can be far more volatile.
The reason for this is the difference in trading hours between the U.S. markets and the country of origin; the time lag can lead to an exaggeration in the effect. The conversion rates between the two currencies can also increase the swing, which is great news if the market moves the right way but not so good if it's heading lower.
Investors in the UK have the option of taking out an ISA to maximize their returns from foreign investments. Although it is possible to invest into a cash ISA, there is a range of slightly higher risk options for an ISA holder. An ISA allows investment into depository interests providing there is an underlying link to a recognized stock exchange as well as Eurobonds.
One of the big advantages that an ISA holds over other types of investment is its flexibility, which combined with its tax breaks, makes the ISA a popular option. Unfortunately for U.S. investors, an ISA is only available to residents in the UK.
Experts in overseas investment suggest that in order to reap the real benefits of foreign economies, it is essential to target smaller companies that aren't globalized like their broadcap multinational peers. Smallcap stocks have far more weight within their domestic economy, which when investing overseas is the opportunity you are trying to exploit.
It's a Small World
Foreign markets have gradually become more important for U.S. investors and are predicted to continue to grow. Thirty years ago U.S. stocks made up 66% of the global stock market capitalization, a figure that has now dropped to just 40%.
Even trading straight stocks in overseas exchanges can bring greater returns than by sticking to U.S. shares. The S&P 500 returns have consistently been nothing more than mediocre compared to other markets, with an average yield of 3%.
Even avoiding more volatile economies and sticking to developed countries such as Australia, the UK, Singapore, Germany and New Zealand, it is possible to achieve returns in excess of 5%. This potentially greater return coupled with the decline of the dollar means that gains are twofold.
India has been predicted to become the fourth largest global economy by 2030, while Brazil, Mexico and China are also contenders to increase in significance. In the UK, it is possible to purchase an ISA that offers the opportunity to capitalize on the surge in Indian wealth. ISA options also include the other BRIC nations, which are Brazil, Russia and China.
There are many different options to enjoy the growth available in foreign markets, but whatever you select experts recommend that you place around a third of your portfolio in economies operating independently of the U.S. dollar.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.