Foreign investment increases an investor’s investment options, an aspect known as portfolio diversification. Portfolio diversification mitigates investment risks as it reduces the chances of an investor losing all returns as would be the case when investment is centralized. There are two major reasons for international investment that include diversification and the variation in growth rates for the different countries. International investment posses several risks that include extra costs of investment, higher chances of loss in returns that result from changes in exchange rates and legal risks. Investments mediums include, depository receipts, exchange traded funds and international mutual funds.
Foreign investment involves the expansion of business ventures in the international market. Foreign investment leads to the spread of business risk across international boundaries that often have a variation in risks likely to be faced by a business. The spread of business risk across international boundaries or across a wider variety of investment options is referred to as portfolio diversification. There are various methods in which a business could accomplish portfolio diversification. A business could venture in asset diversification that involves the use of a wider variety of securities such as holding a portfolio of bonds, stocks and treasury bills. It could also include currency portfolio diversification that entails the investment of one’s assets in different currency denominations. This ensures that the investor is hedged against any form of loss in value of the local currency.
Reasons to invest internationally
The two major reasons why people opt to explore international markets are diversification and growth variation. Foreign investment is effective in diversifying ones investment portfolio as it provides an individual with the opportunity to invest ones assets in various countries. This gives the investor the opportunity to spread investment risk. Different companies in the different countries face varying rates of making losses. The investors are less likely to suffer huge losses that would result from concentrating ones resources in a single country. An individual or institution that invests in different countries that use different currencies hedges his investment against the weakening of a single currency that is in use locally.
Different countries have varying degrees of economic growth. Investments in the international market increase the chance that the investor will earn more as compared to an individual who concentrates investments in the local market. Similar industries in different markets experience varying degrees of growth rate. The returns to the investments made in different markets are likely to be more as compared to the returns obtained from local investment.
International investment risks
International investment provides the investor with the opportunity to increase returns. Investors in the international market also face certain risks associated with international investment. The international markets face an increased chance of contingencies. Political instability, terrorism and civil wars adversely affect investment returns. The terrorist attack to the United States is a clear example of the risk that investors would face while investing in the international market. Investment in different countries that use different currencies increases the chance that an investor may suffer huge losses. Changes in the exchange rates between countries may adversely affect returns especially if the foreign currency depreciates in value in comparison with the local currency. Foreign companies pay the returns on their local currency that is then exchanged for the investor to his local currency. A weakened exchange rate translates into reduced returns and the imposition of controls by some countries that restrict and delay the exchange of its currency to international investors.
International investment in some countries may be limited. It may result from the fact that the country has imposed policies that limit the number of stocks that foreigners may buy. Foreign investment may also be expensive in comparison to local investment. Some countries impose extra charges inform of additional withholding taxes, premiums and transaction fees to foreign investors. This increases the cost of investment relative to local investment a factor that translates into reduced returns. Other risks associated with international investment include legal barriers where local investors in the international markets are favoured in court proceedings, inaccessibility of up to date information in the foreign markets.
Mediums of international investment
There are various ways in which an investor can invest internationally;
International Mutual funds
This involves the buying of stocks in different countries. This medium of investment is advantageous since it provides more stock options that consequently increase an investor’s investment portfolio. In addition to this, one can invest at the prescribed minimum rate and provides the investor with a chance to spread his risk across different stocks with a fixed sum of money.
Exchange traded funds
This is an investment medium that aims at obtaining similar returns by matching market indices. The fund enables investors to invest in stock indices represented in the foreign companies.
These are unique to the different countries. They involve the purchase of stocks in exchange of a certificate of ownership. The United States has a fixed number of depository receipts available to international investors and thus more competitive.