Investing in foreign dividend stocks is one way to diversify a portfolio. It opens up a whole new area of commerce that can bring excellent returns to an investor?s pockets. However, as with any investment, there are certain risks involved when buying foreign dividend stocks. With a little due diligence, patience, and practice any investor can utilize foreign dividend stocks to add to their investment returns.
Sometimes investors get so caught up in the domestic stock markets that they totally miss a wonderful opportunity to invest in companies abroad. To some it might seem like a daunting task to put money into an area that is so, for lack of a better term, foreign to them. Though the United States stock markets are the largest in the world, 50% of the world?s stock market investing opportunities are outside of the USA?s borders. That means that by strictly investing domestically an investor is missing half all trading and investing potential in the world!
But you do not necessarily have to focus on foreign stock exchanges to invest in foreign companies. American Depository Receipts, or ADRs, allow foreign companies access to trade on the NASDAQ, New York Stock Exchange, or another domestic stock market. Investors are able to purchase shares in the form of American Depository Shares, or ADS, in US currency. They are bought and sold like regular shares and still pay dividends. It is an easier and more familiar vehicle to get involved with foreign stock trading.
Another way to get involved in foreign stock trading is actually trading on a specific stock exchange, like the Tokyo Stock Exchange or the London Stock Exchange. By investing abroad, it can limit the potential losses brought about due to American instability. Many investors are currently worried about the US market because of economic troubles and mounting debt. Putting money in foreign and emerging markets allows investors to diversify their portfolio and hedge against economic troubles domestically and abroad.
There are also possibilities to see tremendous gains in emerging markets across the globe. For example, if an investor were to have invested in South Korea, Hong Kong, Singapore, and/or Taiwan (the Four Asian Tigers) in the 1990?s, they could have seen gains in markets that grew at higher than normal rates. While these are unusual circumstances, there are always opportunities all over the world for markets to experience higher growth rates than domestic markets. It may take time and research, but the potential gains are out there if an investor is willing to put in the work.
By the same token, however, dangers exist in foreign markets. The Shanghai Composite Index, a Chinese benchmark, has fallen nearly 16% from its highs over the past year. In contrast, the U.S. benchmark S&P 500 currently sits right near its yearly highs. Clearly, timing is essential.
So while foreign stocks do bring about a plethora of opportunities, there are definite drawbacks to investing abroad. Here are 5 potential concerns for foreign dividend stock investing:
1. Tax Issues
An investor must be careful when investing in foreign stocks because of certain tax implications. Many countries will tax dividends paid out to foreign investors at a higher rate. So the 7% dividend yield paid out by a company can actually be significantly less if the country deducts a significant amount of withholding taxes.?However, some countries, like the UK, India, and Argentina, do not tax dividends paid to US residents at all. This fact is due to agreements between the U.S. and those countries to not impose dividend taxes on each other.
Such cases are the exception, not the rule, however. Some of the larger withholding tax rates by some countries on dividends paid to U.S. residents are:
- Australia: 30%
- Brazil: 15%
- Canada: 15%
- Germany: 26.4%
- Mexico: 10%
- South Korea: 27.5%
Luckily, the IRS has a foreign tax credit that an investor can use to deduct the taxes paid to the foreign government. This is in place to help avoid double taxation of dividend income (i.e. the IRS does not want to tax you on dividends that a foreign government has already taxed you on). However, there is a limit to the amount of foreign tax credit received. No one at Dividend.com is a tax specialist, so the best thing an investor can do when faced with tax issues is talk to an accountant.
2. Political, Economic, and Social Instability
While foreign investing can be used to hedge against potential domestic economic issues, it can also be a drawback for the same reasons abroad. Political, economic, and social instability might occur in whatever country an investor might have money in.
Most of the time it is harder to get a pulse on the potential instability a foreign country might face, which is why it is more of a drawback than potential instability domestically. Things like war, acts of terror, civilian unrest, or even natural disasters can dramatically change the economic outlook for a given country, and therefore the companies within its borders. New taxes might be imposed on foreign dividend payments or the companies invested in might be overtaken and nationalized by the country?s government. These factors all have an effect on the returns on investments and must be taken into consideration when determining where investments take place.
3. Dividend Payout Fluctuations and Unusual Schedules
Many times foreign dividend stocks have unusual dividends that do not mirror the rigid monthly, quarterly, or annual payout schedules that US investors are accustomed to.? There are sometimes no set payment amounts ? for instance the past four dividend payouts for Unilever (UL
) (a British and Dutch company) have been 29 cents, 32 cents, 30 cents, and 31 cents, respectively. So if an investor is counting on regular income at regular intervals, more research will need to be done to determine what stocks are right for the situation.
4. Regulatory Differences
Not every country has the amount of regulations and accounting principles that are seen in the United States. Financial disclosure and corporate governance vary greatly abroad. This fact can make it difficult to properly analyze a foreign firm or economy to make sure an investment is being made smartly.
For instance, there are many questions on the validity of China?s own financial statements and thus the companies within its borders.? It is hard to tell whether certain Chinese firms are actually operating at a level that matches their financial releases. The time and effort spent to properly analyze and find financial information could be used in a more efficient manner where return on time and investment is greater.
5. Lack of Liquidity
Not all countries have the highly developed market to instantaneously trade securities at the click of a button like we accustomed to with our stock exchanges. This factor can make it difficult to trade in a quick convenient manner. If an investor needed to sell and get out of a market, it might not happen as quickly as one would like. Because of this, an investment timeline and the level of liquidity desired must be considered by investors so there are no surprises if a cash out is needed in a time sensitive manner.
The Bottom Line
Foreign dividend stocks might not be for everyone. The additional time and effort needed to research foreign companies could be a hindrance for maximizing returns. However, for those investors who have the time and patience to put in the work, investing in?foreign?dividend stocks can be a great way to diversify a portfolio and increase potential return?opportunities. Sometimes it pays off to expand horizons and put in a little elbow grease to make the most out of investing.
Be sure to visit our complete recommended list of the Best Dividend Stocks, as well as a detailed explanation of our ratings system here.
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Source: http://www.dividend.com/blog/?p=54377
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