stock market basics for beginners | 4 Pros & Cons of Investing in International Funds

4 Pros & Cons of Investing in International Funds

David Bakke is a writer for Money Crashers Personal Finance, where he covers topics like stock market investing and saving for retirement.

Saving for retirement is essential – especially with the questionable future of Social Security and other government programs, such as Medicare, facing serious cuts. But what is the best way to go about it?

A good start is to seek diversification in different investments, as this can prepare you for a variety of scenarios when you retire. For example, investing in both a 401K and a Roth IRA provides some protection against an unknown future tax environment. But within those accounts, what investments should you hold?

This is a tricky topic, especially as the economy continues to struggle. However, the fact remains that investing for growth is essential, especially if you are many years away from retiring. One promising option is to invest in international funds.

Benefits of International Investing

1. High Yield
Many international funds pay higher dividends than U.S. domestics. For example, the average dividend yield for blue-chip stocks in Europe and Asia is right around 3%, which is well above the current 2% yield on the S&P 500. There are also multiple high-yield international ETFs generating more than 10%.

2. Diversification
International investing is roughly broken down into 2 categories: developed markets and emerging markets. Developed markets generally carry less risk than emerging, though emerging markets may offer more opportunity for growth.

You can invest in stocks and bonds in either category in a range of sectors and countries. Moreover, international markets do not always move in tandem with U.S. markets. In other words, when your domestic funds are down, your international holdings could be up. This provides yet a further layer of diversification to portfolios that incorporate both U.S. and international funds.

3. A Weak Dollar
The dollar didn’t just weaken recently – it has under-performd for years now. If the trend continues, gains you take overseas will have more buying power domestically. That said, there are plenty of foreign countries experiencing their own financial woes these days. So do your homework to find countries with a strong currency now and the economics to keep it that way.

4. Growing Market Competition
The trend towards globalization means that the rest of the world is gaining an edge over the U.S. in various industries. For example, a cheaper labor force can allow U.S. competitors room to grow, especially when products or services are exported worldwide. As evidenced by plenty of domestic corporations expanding their overseas presence, it’s becoming harder for companies operating solely out of the United States to remain competitive.

Drawbacks to International Investing

Though the benefits are compelling, keep in mind that investing internationally comes with risks typically not associated with domestic funds.

1. Currency Risk
Fluctuations in local and foreign currencies can also work against you. If the dollar rises and foreign currencies decline, your international gains will suffer proportionately when converted to U.S. currency.

2. Foreign Unrest and Regulations
Your overseas investments can also be vulnerable to volatile politics and foreign economies. For example, a new regime could undo generous business legislation that the previous regime enacted, which could have a detrimental effect on your investments. Generally, less stable countries and economies will be more susceptible to market fluctuations as a result of political and social uprisings.

3. Lack of Familiarity and Information
If you decide to invest internationally, you will likely be unfamiliar with the companies in which you’re invested – especially since funds invest in multiple companies. This lack of information limits your ability to make fully informed decisions regarding those companies’ prospects. Moreover, corporate financial statements may be more susceptible to “loose” accounting, particularly in countries without established and independent oversight committees.

4. Higher Expense Ratios
The expense ratios on international ETFs are relatively high compared to their domestic counterparts. Expenses including the expense ratio and any sales charges should always be considered before investing, as these seriously deteriorate gains during the years you’ll be invested.

Final Thoughts

Opportunity awaits internationally. Globalization is real and this is no longer the same world our parents invested in. That said, plenty of risk still exists as well, which is why it’s wise to allocate only a percentage of your portfolio to international funds. That percentage will depend heavily on what you’re investing for, the length of time you plan to invest, and your tolerance for investment risk.

If you have many years until retirement, you can better withstand the risk of investing in an emerging markets fund than someone just entering retirement. Plus, you’ll probably need the aggressive growth factor. International funds may also provide some protection against an ailing domestic economy.

What are your thoughts on investing in international funds?

No related posts.

Filed Under 2011 Investing, Trading Strategies | Leave a Comment

Tagged With

Comments

Leave a Reply