If you’re new to the world of investing and the stock market, the idea of diversifying your portfolio by investing in foreign stocks may sound out of reach. However, this is a popular strategy used to attempt to mitigate risk and benefit from the expansion of the global economy.
There are both developed and emerging markets around the world full of opportunity. The global economy is always changing, and although U.S. stocks are likely the most familiar to Americans, they aren’t always necessarily the best investment.
Whether you’re interested in investing in the global stock market or focused solely on the U.S. market, having knowledge about foreign markets can help you make informed decisions about your portfolio.
How Does the Global Market Differ From the U.S. Market?
If you are invested in the U.S. stock market, you are already participating in the global economy. More than 40% of the revenues generated by publicly listed companies in the U.S. come from overseas customers. And many U.S. companies make much of their revenue outside the U.S.
While it may seem as though this makes foreign investing unnecessary, U.S. stock markets still differ from foreign ones.
Emerging markets can also offer a different type of investment from developed ones, like the U.S.
The U.S. stock market is made up of publicly traded U.S. companies. The three major U.S. stock exchanges are the New York Stock Exchange (NYSE), the National Association of Securities Dealers Automated Quotation System (Nasdaq), and the NYSE American, formerly known as the American Stock Exchange.
Other exchanges in the U.S. include the Chicago Stock Exchange (CHX), the National Stock Exchange (NSX), and the Boston Stock Exchange (BSE). Note that not all companies listed on these exchanges are U.S. companies. For example, there are around 156 Chinese companies listed on the three biggest U.S. exchanges.
The U.S. market is the largest in the world, but it is shrinking in both size and productivity. In the year 2000 the U.S. market was 50% outperforming GDPs . U.S. stocks have been outperforming both GDPs and international stocks.
This is partly because U.S. companies have been attracting capital from around the world. Although this has caused some investors to question the value of investing in foreign markets, there are still multiple reasons why it might make sense to diversify.
Developed vs. Emerging Markets
The primary differences between developed (i.e. the U.S.) and emerging markets is that developed markets have more robust infrastructure, financial markets, security, political institutions, and industries, whereas emerging markets are still working on building those areas out.
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Emerging markets offer the potential for more growth since they are in earlier stages, and they offer an additional option for diversification of your portfolio.
Though emerging markets are performing well over longer time frames, they are considered riskier, due to the volatility of currency, policy changes, political unrest, liquidity risks, and other factors.
The two biggest emerging markets are China and India China is similar to the U.S. in that its stock market only takes up a fraction of the nation’s economy. Public Chinese companies can be risky investments, however, because they tend to have high levels of debt and poor disclosure of their finances.
You may have heard the terms “the Dow” and “the Nasdaq” tossed around when referring to the markets. These are both indexes of stocks which give a broad indication of how the U.S. market is performing.
The Dow Jones Industrial Average (DOW) is a price-weighted average of 30 blue chip companies. The Nasdaq may refer to the Nasdaq exchange mentioned above, but in this case it refers to the Nasdaq composite, which is an index of all the companies listed on the Nasdaq exchange. There are only a few companies which overlap onto both indexes, as most of the stocks in the DOW are listed on the NYSE.
There are numerous other U.S. stock indexes as well, such as the S&P 500 and the Wilshire 5000. Some indexes group companies by industry, while others average many of the mid-sized or smaller public companies to give a different perspective on the market.
Index investing has recently become popular, which means investing in a passive index fund. Index funds group together stocks from an index. When these indexes go up or down, it can give investors insight into the overall strength of the market, but it is not the market itself.
What Are the Main International Markets?
Each country has its own stock exchanges and publicly traded companies. Similar to the U.S., there are indexes of foreign stocks in which you can invest. Some of the larger markets are:
The main stock indexes in Europe are the FTSE in the U.K., the CAC 40 in France, the DAX in Germany, and the Swiss Market Index in Switzerland. The primary exchange in the U.K. is the London Stock Exchange—it is the largest in Europe .
In Asia, the main indexes are Hang Seng in Hong Kong, Mumbai Sensex in India, the Shanghai Composite in China, and Nikkei in Japan. Australia has the Australia ASX index and the Australian Securities Exchange.
The third largest stock exchange in the world is Japan’s Tokyo Stock Exchange. China has two large exchanges: the Shanghai Stock Exchange and the Hong Kong Stock Exchange.
North and South America
In North America, Mexico has the IPC and Canada has the S&P/TSX. Brazil’s market is the Brazil Bovespa and Chile has the Santiago Index. Brazil’s stock exchange is the BM&F Bovespa. Canada has the Toronto Stock Exchange (TSX).
Why Some Invest in Foreign Markets
Traditional finance gurus will likely tell you that any time you can add something to your portfolio that doesn’t behave like everything else in your portfolio, it’ll increase your diversification.
Increased diversification is a good thing because it reduces the chance that any one investment or one class of investments will have an outsized effect on your portfolio performance. Since different factors affect US companies and non-US companies, the different markets perform differently over time.
Sometimes the US is the best performing market, but sometimes it isn’t. Having a piece of all the markets ensures that if for some reason US stocks suffer a setback unique to them (demographic trends, political issues, etc.), your international stocks may outperform.
The concept of diversifying your portfolio means that rather than putting all your money into one asset or asset class, you spread it out over multiple assets.
That way, if one of your investments in a specific asset class loses a significant amount of value, you don’t lose as much in the rest of your portfolio. And if one asset gains significant value, you still benefit.
Since the 2009 recession, numerous factors have disrupted both the U.S. and foreign markets. From Brexit to trade disagreements with China, these have been volatile times. However, this is not abnormal.
Stock performance can change dramatically from year to year. Just because one country outperforms another for a year or two doesn’t mean the trend will continue that way.
If you’re building a portfolio geared toward long-term growth, one strategy is to spread money out over multiple assets and regions to be better equipped to handle the ups and downs of the market.
Every investment has its risks, so having more options to choose from is a good thing. Currently, the U.S. stock market is shrinking. Fewer companies are choosing to go public as more private funding has become available to startups, and low interest rates have made borrowing easier. Companies are also waiting longer to go public.
There are currently around half as many companies listed on U.S. exchanges as there were in 1996. Although the European market is also shrinking, it’s to a lesser degree.
The World Is Changing
Emerging markets in Asia, Africa, and South America are starting to show strong economic performance and growth. With the U.S. market getting smaller, geopolitical shifts such as Brexit, the rise of cryptocurrencies, and other factors, it might be a good idea to spread out your investments to mitigate risk.
Even if one country’s market is stronger than another now, that can always change.
Risks of Investing in Foreign Stocks
Every investment comes with risks. It’s important to evaluate each stock you invest in and consider its potential pros and cons. A few concepts to be aware of when investing in foreign stocks are:
Some countries have more buyers and sellers than others. Be aware of limited trading hours and lower volumes.
Every country has its economic and political issues, and these can affect the markets. It’s important to keep an eye on things like war, corruption, and currency swings.
In the U.S. the Securities and Exchange Commission (SEC) protects investors from fraud. Not every country has the same type of protections.
In the U.S. there are certain requirements for companies to report their earnings and other important data. This type of information may not be available from companies in other countries.
How to Get Started Investing in the Global Stock Market22% of their portfolios to international stocks. However, some studies have shown that the optimal allocation is 40%. Consider starting out small and adding more as you continue to build your portfolio—see what works for you.
An easy way to begin adding global stocks to a portfolio is through mutual funds or ETFs. Choosing individual stocks to invest in can be challenging, costly, and time-consuming, so these funds combine stocks for you. Some funds group stocks by country, others by industry or market.
One thing to remain aware of are any transaction costs and foreign taxes, which may be higher than those you pay for U.S. transactions.
Becoming a Global Investor
With emerging markets around the world growing and geopolitical issues always shifting, you may wish to consider diversifying your portfolio into the international market to potentially mitigate risk.
You can become an international investor by adding certain mutual funds and ETFs to your portfolio. Or if you’re just getting started with investing, perhaps you’d like to stick to U.S. stocks.
Either way, choosing your first stock investment can be overwhelming. The SoFi team is available to help answer your investment questions, and get you started.
SoFi Invest® offers both active and auto investing tools. You can either select each stock you want to buy with active investing, or let the automated tools do it for you. With zero fees and flexible investing options, SoFi can handle all of your investment needs.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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