However, much has happened since it went up, including the Blogger outage. Scroll down for a report on that. More new posts will be added below this one. The essay below is the conclusion of the ninth part in a series by Takuan Seiyo.
To become knowledgeable about a foreign market to the point where the manager can generate good returns, the process involves spending significant amounts of time and money on research and analysis.
These costs will often include the hiring of analysts and researchers who are familiar with the market, accounting expertise for foreign financial statements, data collection, and other administrative services.
For investors, these fees altogether usually end up showing up in the management expense ratio. One way to minimize transaction costs on buying foreign stock is through the use of American depositary receipts ADRs.
ADRs trade on local U.
It should be noted however, that although ADRs are denominated in U. Currency Volatility The next area of concern for retail investors is in the area of currency volatility.
If you then hold the foreign stock for a year and sell it, you will have to convert the foreign currency back into USD at the prevailing exchange rate one year later. It is the uncertainty of what the future exchange rate will be that scares many investors.
Also, since a significant part of your foreign stock returns will be affected by the currency returns, investors investing internationally should look to eliminate this risk.
The solution to mitigating this currency riskas any financial professional will likely tell you, is to simply hedge your currency exposure. However, not many retail investors know how to hedge currency risk, or which products to use.
There are tools such as currency futures, options, and forwards that can be used to hedge this risk, but these instruments are usually too complex for a normal investor.
Alternatively, one tool to hedge currency exposure that may be more "user-friendly" for the average investor is the currency ETF. This is due to their good liquidity, accessibility and relative simplicity. Liquidity Risks Another risk inherent in foreign markets, especially in emerging marketsis liquidity risk.
Liquidity risk is the risk of not being able to sell your stock quickly enough once a sell order is entered. In the previous discussion on currency risk we described how currency risks can be eliminated, however there is typically no way for the average investor to protect themselves from liquidity risk.
Therefore, investors should pay particular attention to foreign investments that are, or can become, illiquid by the time they want to close their position.
Further, there are some common ways to evaluate the liquidity of an asset before purchase. One method is to simply observe the bid-ask spread of the asset over time. Illiquid assets will have wider bid-ask spread relative to other assets. Narrower spreads and high volume typically point to higher liquidity.
Bottom Line Investing in international stocks is often a great way to diversify your portfolio and get potentially higher returns. However, for the average investor, navigating the international markets can be a difficult task that can be fraught with challenges. By understanding some of the main risks and barriers faced in international markets, an investor can position themselves to minimize these risks.
Lastly, investors face more than just these three risks when investing abroad, but knowing these key ones will start you off on a strong footing. For additional reading, also check out Going International.
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