International markets can offer high potential returns, but it’s important to remember that more return potential means more risk potential: as we’ve seen in recent months, China’s currency and production challenges have had negative repercussions around the world.
Currency fluctuation is a significant risk. The value of foreign currency fluctuates with changes in the supply of and demand for both the foreign currency and the U.S. dollar. If your investment in a European security appreciated and at the same time the euro strengthened relative to the U.S. dollar, for example, your actual return would reflect both the appreciation of the investment and the strength of the euro. The strengthening of the euro is caused by changes in the supply/demand ratio for the euro, the U.S. dollar, or both. On the flip side, if the euro weakened relative to the U.S. dollar, your investment return would be affected adversely, even though your investment appreciated.
Compounding this problem is the fact that in some foreign markets, particularly small ones, it’s difficult to trade certain securities. For any number of reasons, you may experience difficulty finding buyers for a foreign security you wish to sell. You are thus forced to accept the price offered, which may wind up being less than your initial investment.
Although the risks involved with foreign investments cannot be completely eliminated, there are ways of managing those risks. Mutual funds are one: in addition to providing professional management, mutual funds enable you to diversify by investing in a portfolio representing various regions, countries, and industries (though, of course, this varies by fund.). Buying individual stocks with an international account with access to multiple markets, using multiple currencies is another.
Investing with a long-term horizon is another way to manage risk. Overseas companies need time to adjust to rapid changes in international political and economic conditions, the pace of technological development, and global competition. Because short term fluctuations are typical when investing abroad, it’s especially important to maintain a long-term perspective.