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There are three ways you can invest internationally: through mutual funds, American Depositary Receipts, or direct investments in foreign markets. Mutual funds are, by far, the easiest way to invest and offer a number of choices. Global funds invest all over the world, including the U.S., while international funds generally limit their investments to companies outside the U.S. Regional funds specialize in stocks from one region of the world, such as Latin America or Europe, and country funds invest in just one country.
American Depositary Receipts, or ADRs, allow shares of companies traded on foreign stock exchanges to trade on U.S. stock exchanges. An ADR is actually a registered security issued by a U.S. bank representing shares of a foreign stock. When you buy and sell ADRs, you are trading in the U.S. market, and your trade is settled in U.S. dollars.
Most investors who buy stocks in foreign companies cite increased diversity as their key motive. Since international markets sometimes behave differently than U.S. markets, spreading your investment risk among several countries can help lower the volatility of your portfolio and may limit your losses should a particular market fall.
Investing abroad also opens new opportunities for potential growth, particularly within emerging markets. Of course, you need to balance these potential advantages against the challenges and risks inherent in investing abroad.
Investing in international markets poses three key areas of risk. The first involves currency risk. Changes in the exchange rate between the foreign currency of an international investment and the U.S. dollar can increase or reduce your return.
The investor who buys stock in foreign companies must also be aware of political, economic and social factors that may affect the value of his or her investment. Changes in political leadership, civil unrest or restrictive trade agreements are several examples of events that can affect market returns. Fund management fees are also often higher to compensate for the added skill and research required to invest overseas. This increased expense will affect your overall return.