International investing can be a tricky endeavor, from language barriers and currency conversions to foreign exchanges and regulations. But at the same time, most financial advisors recommend holding at least some foreign stocks in a diversified portfolio. Fortunately, there are several easy ways to invest in foreign markets without picking up a new language or exchanging dollars for euros. Here is how to diversify abroad with U.S.-traded stocks and funds, as well as some important considerations for doing it properly.
Easily Diversify Abroad with ETFs and Mutual Funds
The easiest and most common way to invest in foreign markets is by purchasing exchange-traded funds (ETFs) or mutual funds that hold a basket of international stocks and bonds. With foreign holdings across multiple industries and countries, these two fund types provide investors with a quick and highly-diversified foreign component to their portfolio in just one easy transaction.
Investors can also choose between many different types of mutual funds or ETFs, including:
- International Funds invest broadly across many countries outside of the U.S.
- Regional Funds invest in specific regions, like Europe, Asia or the Middle East.
- Country Funds invest in specific countries, like Spain or Russia.
- Sector Funds invest in particular sectors across multiple countries, like gold or energy.
How to Find the Best Fund for Your Portfolio
So, what fund type is best for you? Ultimately, the answer to this question depends on the individual's investment objectives and appetite for risk. In general, mutual funds are actively managed by professional investors, while ETFs are passively managed with holdings based on a preexisting index. As a result, mutual funds tend to be more expensive than their passively managed counterparts.
Once the right type of fund is selected, the next step is determining where in the world to invest. Most financial advisors recommend that younger investors seek higher-risk funds with the potential for greater returns, while older investors seek lower-risk funds that offer more stability. This often translates to greater emerging market exposure for younger investors and developed market exposure for older investors.
Finally, finding specific mutual funds is easiest using free online tools like the Yahoo! Finance Fund Screener or the Wall Street Journal Fund Screener. Meanwhile, ETFs can be found by browsing through some of the largest ETF providers, like iShares or SPDRs. In the end, investors should seek out low-cost, high-return funds that meet their investment objectives and risk appetite.
Buy Individual Foreign Stocks Hassle-Free with ADRs
Investors that prefer a hands-on approach can easily purchase many individual foreign stocks using American Depository Receipts (ADRs), which are U.S.-traded securities that represent ownership in the shares of foreign companies. Since they are denominated in dollars and traded on the NYSE, NASDAQ or AMEX, ADRs do not require any complex currency conversion or foreign exchange transactions.
Unfortunately, there are many foreign stocks that aren't available as ADRs and must be purchased on foreign exchanges, such as the Toronto Stock Exchange (TSE) in Canada or the London Stock Exchange (LSE) in Europe. While some international brokerages offer a cheap way to purchase these stocks — such as InteractiveBrokers — investors should carefully check their brokerage's fee schedule before trading.
Note: While buying and selling of ADRs occurs in U.S. dollars, any dividends issued will be denominated in the foreign currency and then converted into U.S. dollars upon distribution. As a result, there may be some currency exchange rate risk involved in those situations.
How to Find the Opportunities in International ADRs
Similar to international funds, investors should select individual stocks based on their investment objectives and appetite for risk. Investors looking for relatively safe bets can seek out larger established companies with ADRs, like Sanofi-Aventis SA (NYSE: SNY) or Rio Tinto plc (NYSE: RIO). Meanwhile, those looking to take on more risk may find more undervalued opportunities in smaller ADRs.
Individual ADRs can be found using the same stock screeners used to find individual U.S. stocks, since the securities trade on U.S. exchanges. One of the best free stock screeners online is Finviz's stock screener that offers the ability to screen stocks based on a wide range of metrics.
The Bottom Line
International funds and ADRs are great ways to build international exposure into any portfolio without having to worry about foreign stocks or regulations. By keeping the aforementioned tips in mind, investors can be well on their way to achieving proper diversification for their portfolios!