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Currency fluctuation is something you need to pay attention to when investing internationally. That fluctuation can increase or decrease the dollar value of an investment.

1. Market performance: one component of fireign investing
2. Currency translation: supply and demand of a currency fluctuates the price of securities. Local currency investors of a certain country will have different returns than you will have in the U.S. on the same investment.

When U.S. investors purchase foreign securities you have to convert the amount from the U.S. dollars to local currency. When sold they are converted back to dollars. So a strengthening dollar reduces the value of the foreign investment by an American and a weakening dollar increases the value of the foreign investment.

Example, in 2000 UK stocks returned -4.5% to a local investor and the pound depreciated (-7.2%) versus the dollar giving the U.S. investor a return of -11.8%. So this goes to show you that it is important to understand the effects of currency fluctuation.

You can never completely rid yourself of risk in your portfolio, but diversification will help you sleep at night. Investing internationally will help your risk/return trade-off, but foreign investments have some risks the domestic stocks do not.

1. Currency Risk: Changes in foreign currency rates can effects the returns of foreign investments. Exchange rates change constantly because of supply and demand of countries’ currency. Also, when you sell a foreign security or receive dividends there needs to be a currency conversion. Change in foreign currency rates can increase or decrease the dollar value of an investment even if the foreign security remains unchanged.
2. Economic/Political Risk: Economies around the world do not possess the diversity or stableness of the U.S. Political unrest can have major negative results on foreign investments’ returns. So understand the politics of the country before diving in.
3. Market Liquidity Risk: This risk is if a security becomes difficult to sell in a secondary market. Most foreign stock do not trade in the volumes that U.S. stocks tarde.
4. Differences in Accounting Standards: With all the accounting malfaesance that has gone on in the U.S. this decade it is easy to see how a country’s accounting rules can significantly affect a stock. Most standards are quite different from the U.S. model.
5. Costs of Investing Internationally: For all the reasons we discussed, investing in foreign markets typically has higher expenses than domestic. Obviously, this can reduce your overall return.

Take two portfolios: one is a Domestic investment portfolio and the other is a Global portfolio. When you examine the Domestic portfolio you see that it contains 60% U.S. stocks and 40% U.S. bonds while having an average return of 11.5% and risk of 10.9%. Now take the Global portfolio–42% U.S. bonds, 41% U.S. stocks and 17% International stocks. This mix results in the same average return of 11.5%, but a lower risk level of 10.2%. So this is another example to show how diversification pays int he long run. You get same/similar returns while lowering your risk.

As you now know you can help your portfolio’s risk/reward trade-off by including international stocks with your domestic investments.

By expanding the the set of domestic portfolios to include foreign stocks you can improve that risk/reward trade-off. In comparing a portfolio of domestic stocks and one with global investments you can receive higher returns at certain levels of risk. Because of the low correlation between domestic and foreign stocks they complement one another very well and will help your portfolio in the long-run.

Investing abroad will enable you to to take advantage of broad diversification.

The world is in flux constantly and investing internationally is essential to having a well diversified investment portfolio. Examine this: Take the period of 1969-2000 and invest $1,000 in a global, U.S., European and Pacific based portfolios. Which performs best?

The global one outstrips the others with a result of $46,849 at a 13.2% average clip. The U.S. and European portfolios are not terribly far behind, but when you consider the benefit of lower risk in a global portfoliothe benefits are even more important. pacific stocks lagged with a $32,505 result, but in the future those stocks might perform best. You never one where will be the leader so by covering all your bases you will be best positioned to take advantage of this.