International stock investing

Key Points

• The Investment World Grows Larger
• Diversification and Higher Returns
• How to Invest in Foreign Equities
• Special Risks of International Investing
• Points to Remember

Investing internationally has grown rapidly in recent years. The bias for investing only within our national borders is diminishing, as an increasing number of individual and institutional investors boost their international exposure to pursue their investment goals. Behind the trend toward international investing are the realizations that the global market can offer attractive opportunities for investment and that diversification abroad can help reduce risk.

Shift in U.S. and World Market Capitalizations

Source: Standard & Poor's The World by Numbers: Global Stock Markets Review, December 2008. CS000175.

Back to top

The Investment World Grows Larger

In 2008 foreign markets represented 56% of the world's investment opportunities. It is estimated that by 2030 the U.S. stock market will represent just 35% of the world market.¹

Back to top

Diversification and Higher Returns

The quest for diversification and higher returns are driving forces behind the internationalization process. When U.S. investors began to invest in foreign equities, a key reason for the move was increased diversification. Because international markets do not always move in sync — some may zig while the others zag — diversification on a global scale may help offset the effect of a downturn in the U.S. market. Investors in international securities may face additional risks, such as higher taxation, less liquidity, political problems, and currency fluctuations, that do not affect domestic investors. But despite these risks, the potential for higher returns and diversification makes these markets attractive to many investors.

As investors around the world become more sophisticated and aggressively explore investment opportunities, they find that the global arena can offer competitive returns. Morgan Stanley Capital International's Europe, Australasia, Far East (EAFE) Index, which tracks 21 major world markets, posted a 9.4% average annualized rate of return for the 30 years ended December 31, 2008, compared with the 11.0% average annual return of Standard & Poor's Composite Index of 500 Stocks (S&P 500).¹ Past performance does not guarantee future results.

This difference in returns is due in part to differences in economic and market environments in countries around the world. For example, the Japanese market throughout the 1990s, for example, was depressed due to the country's economic recession. Many Japanese stocks became undervalued, providing a buying opportunity. In 1999 the Japanese stock market bounced back, producing a gain of more than 60%.²

Back to top

How to Invest in Foreign Equities

One way you can include international exposure in your portfolio is to invest in stocks of U.S. companies that derive a large portion of their annual revenue from overseas markets. Examples of such companies are Coca-Cola and McDonald's.

You can also buy stocks of foreign companies through American Depositary Receipts (ADRs) - traded on the New York Stock Exchange - and through mutual funds that invest in foreign companies. ADRs are negotiable certificates that represent the shares of a publicly traded foreign company. ADRs are issued in the United States and their underlying shares are held in U.S. banks.

But familiarizing yourself with international markets (including the regulatory, political, and economic environments) is time consuming, and access to company information can be difficult to obtain. An easier way to invest internationally is to buy shares of broadly diversified international mutual funds or exchange-traded funds, which invest exclusively overseas, or global funds, which may buy a mix of foreign and U.S. stocks. These types of funds offer instant diversification through an array of foreign market stocks.

For more experienced and more aggressive investors wishing to target stocks in particular regions or countries, regional or country funds are also available. These funds are designed to take advantage of specific opportunities in the world's developed and emerging markets, but they do carry an increased risk of volatility.

International Investing

Back to top

Special Risks of International Investing

International investing does present unique risks and considerations. A U.S. investor's foreign-investment return depends on both the local currency's exchange value against the U.S. dollar and the stock price in the local currency. For example, falling currency values and plummeting stock prices in Asian nations in 1998 not only drove down stock prices for international investors in Asia, but also in the U.S., because many American companies depend on Asia for customers. For U.S. investors, currency losses could also stem from a rise in the dollar's value against the currency of the foreign country they are investing in. In the past, currency fluctuations have tended to balance out overextended periods of time, although there are no guarantees this will always be the case. Maintaining a long-term perspective and diversifying international investments can help minimize these risks.

Domestic vs. Foreign Stock Performance

The first chart compares returns on the S&P 500 and the EAFE from 1979 through 2008. The second chart shows when foreign markets (EAFE) outperformed or underperformed domestic markets (S&P 500).

Sources: Morgan Stanley Capital International; Standard & Poor's. Performance is for the 30-year period ended December 31, 2008. The S&P 500 is an unmanaged index generally considered representative of the U.S. stock market. The EAFE is an unmanaged index generally considered representative of international markets. Index performance is not indicative of the performance of a particular investment, and past performance does not guarantee future results. Individuals cannot invest directly in any index. CS000176, CS000173.

Back to top

Points to Remember

1. Global markets can offer increased investment opportunities as well as potential risk reduction by providing additional diversification.
2. The rise of the European and Far Eastern economies has significantly altered the structure of world financial markets. The U.S. stock market recently represented under 50% of world stock market capitalization.
3. An easy way for individuals to invest internationally is to buy shares of global or international mutual funds. More experienced investors can target investments in a specific economy or buy stocks of negotiable certificates (ADRs) representing publicly traded foreign stocks.
4. Foreign investments are subject to additional risks, including the impact of currency fluctuations.

Back to top

¹Sources: Morgan Stanley Capital International (1970); Standard & Poor's/Citigroup (2008). 1970 (estimated) market cap shares are based on weights in the MSCI World Index. 2008 market cap shares are based on weights in the S&P/Citigroup World Equity Index. 2030 estimate based on the relative growth rates of the weights since 1970. Index performance is not indicative of the performance of a particular investment, and past performance does not guarantee future results. Individuals cannot invest directly in any index.

²Sources: Standard & Poor's; Morgan Stanley Capital International. Based on total returns of MSCI EAFE & MSCI Japan Index in U.S. dollars. The S&P 500 is an unmanaged index generally considered representative of the U.S. stock market. The EAFE is an unmanaged index generally considered representative of the international market. Index performance is not indicative of the performance of a particular investment, and past performance does not guarantee future results. Individuals cannot invest directly in any index.

Financial planning services and investments offered through Ameriprise Financial Services, Inc., Member FINRA and SIPC.

International investing involves increased risk and volatility due to potential political and economic instability, currency fluctuations, and differences in financial reporting and accounting standards and oversight. Risks are particularly significant in emerging markets.

Diversification helps you spread risk throughout your portfolio, so that investments that do poorly may be balanced by others that do relatively better. Diversification is not a guarantee of overall portfolio profit or protection against loss.

Investment products, including shares of mutual funds, are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution, and involve investment risks including possible loss of principal and fluctuation in value.