The US has been the obvious choice for geographical diversification as opportunities for international investing and diversification have increased recently as a result of the introduction of various apps and the financialization of savings, which has led to new retail investors entering the Indian Market, considering the obvious reasons such as depth and liquidity of markets, strongest currency, etc.
Throughout FY22, Indians made investments in foreign debt or equities totalling around USD 750 million. In FY23, it’s anticipated that the amount would reach $1 billion. Visit Stockal’s article How to invest in US stock markets if you want to take advantage of the opportunity.
Although the results can frequently be profitable, investing in global stock markets could be difficult for many to balance a portfolio. Investors who do participate have the chance to benefit from the long-term growth potential of numerous emerging markets, which have quicker growth rates than those of those developed countries. Understanding the risks of investing in foreign stocks and how to purchase stocks on international markets are prerequisites for successful investing. Investment in overseas stock markets comes with several difficulties compared to investing in home markets. Successful investors are aware of stock trading which involves risks and have developed plans to get around them to boost returns on their holdings.
If you want to learn more about the risks of investing in US stocks or investing in international equities at any other international stock market, for that matter, read on and do your research.
- Price Fluctuation Risk
Currency risk, often known as exchange-rate risk, results from changes in the exchange rates between different currencies. Currency risk, which may result in erratic earnings and losses, is a concern for investors and businesses with assets or activities abroad. Institutional investors, including hedge funds, mutual funds, and multinational organizations, frequently use options contracts, futures, and other derivatives to manage risk.
To invest directly (and without using ADRs) in a foreign market, you must first convert your local currency into the currency of choice at the going exchange rate. Let’s say you sell the foreign stock after holding it for a year. You will therefore need to exchange the foreign cash back into your local currency. Depending upon which direction the dollar is heading, that could assist or damage your return. Many investors are scared of this uncertainty.
A financial expert would advise you to effectively hedge your currency risk as a way to reduce currency risk. The tools at hand include forwards, options, and currency futures. Most private investors wouldn’t feel comfortable employing these tactics.
Investors in such markets should pay close attention to long-term variables. Even though the market can be unpredictable sometimes, keen investors shouldn’t be discouraged by the daily ups and downs fluctuations. ADRs and mutual funds are just a few options to invest in international stock markets without being confronted with many of the abovementioned concerns. ETFs are a more user-friendly variation of those instruments. These ETFs are often simple to use, and have strong liquidity, and accessibility. Stockal can enable you to buy Stocks and ETFs making purchasing flexible and affordable.
- Understanding the country-specific risks
The uncertainty connected to investing in a specific nation is referred to as “country risk,” and more particularly, the likelihood that this uncertainty may result in losses for investors. Numerous factors, such as economic, political, technical effects, or exchange-rate can contribute to this unpredictability. For instance, country risk refers to the possibility that a foreign state would not honor its debt obligations, hence raising transfer risk. In a wider sense, country risk refers to the extent to which economic and political instability impact the stocks of issuers operating in a specific nation.
When making investments in less developed countries, country risk must be carefully considered. These risks are increased due to the significant turbulence that can be caused in financial markets, to the extent that issues like political instability can damage investments in a particular country. The projected ROI of securities issued within such nations or by enterprises conducting business in such countries may be reduced as a result of such country risk.
Hedging can help investors protect themselves from some country risks, such as exchange rate risk, while other risks of investing in foreign stocks, such as political instability, may not always be effectively hedged. As a result, when experts assess sovereign debt, they do so in light of the country issuing the debt’s business fundamentals, including its politics, economy, social climate, and other factors. Longer-term investments and foreign direct investments—those not made via a regulated system or exchange—have the highest probability of country risk.
- Regulatory Risks or Taxation Risks
When it concerns stock markets, the US state has many tax requirements. Different government agencies regulate many facets of the US economy. Any regulatory changes could affect the industry in which you have investments, driving up or down share values. Indian investors need to be aware of these rules and stay up to date on any changes.
You will have to give up the advantages of investing in your home country’s stock market if you choose to invest in any foreign stock market. Your income will suffer if there are any tax changes or increases in the industry in which you have invested. You must pay the regular 25% tax as an Indian trader whether you sell or buy equities on US marketplaces. Additionally, capital gains tax is levied on US stock market profits in India.
- Liquidity risks of investing in international equities
Liquidity risk is another danger in international markets, particularly emerging countries. This refers to the risk of being unable to swiftly sell an investment at any moment without running the risk of suffering significant losses as a result of an economic or political crisis. The common investor cannot easily hedge off liquidity risk in overseas markets. Foreign investments which are or could become illiquid through the time an investor wants to sell them require special attention from investors.
There are a few standard methods for assessing an asset’s liquidity. One approach is to track the asset’s bid-ask spread over time. In comparison to other assets, an illiquid investment will enjoy a wider bid-ask spread. Narrower margins and high volume usually indicate higher liquidities.
- Currency risks of investing in US stock market
The worth of the investment increases when the local currency appreciates against the U.S. dollar. However, the investment may become completely useless if it falls in value against the US dollar. Additionally, certain nations may implement currency limitations that would prevent or delay the option to “cash out” the local currency.
The risk of losing money owing to unfavourable changes in exchange rates is known as currency risk. Companies and people who conduct business in foreign markets are subject to currency risk. Large multinational organizations and institutional investors like mutual funds and hedge funds use derivatives like options and futures to manage currency risk.
Investors from the United States may want to think about making investments in nations with rapidly rising interest rates and currencies to decrease currency risk. But because excessive debt frequently comes before inflation, investors must consider a country’s inflation. This can lead to a decline in economic confidence, which might push down the value of a nation’s currency. Minimal D/GDP ratios are related to rising currencies.
Bond investments could expose traders to currency risk because they have lower profits to cover currency loss losses. Currency movements frequently double the return on an international bond index. Bonds denominated in U.S. dollars offer more stable yields because currency risk is reduced. A geographically diversified portfolio can act as a hedge against currency fluctuations, thus investing abroad is a wise course of action for reducing currency risk.
- Lack of transparency
The reporting rules in many emerging nations and some advanced economies differ from those in the US. For instance, all companies that are listed on a U.S. stock exchange are required by the Securities and Exchange Act of 1934 to disclose their earnings quarterly and to file the necessary paperwork with the SEC regularly. The 10Qs, 10Ks, and other documents mentioned here could fall under this category. In other nations, these regulations would not be applicable, and it could be challenging to locate reliable information about the company—let alone that accessing the data might be hampered by a language barrier.
The Bottom Line
The US share market offers several advantages, including portfolio diversification, increased dollar value, higher market size, improved liquidity, etc. Additionally, it assists in spreading out and reducing danger. But it’s crucial to remember the fundamental rule that says higher reward equals more risk. If you are a novice investor, it can be difficult to identify the risks of investing in US stocks.
Given the numerous risks of investing in US stock market, Indian investors should exercise great caution. As an investor, you should also stay current on the political, social, and economic developments that affect your investments. Risk can be reduced by investing through a secure system and using a reputable brokerage because they can assist you to choose the best stocks to buy and the associated dangers.
