What risks come with investing in international markets?
Although the rewards of investing in international stocks can be high, there are some risks to consider.
- International markets often see outsized impacts when economic conditions worsen.
- Political instability and other developments in the country can devalue an investment, and the values of currencies fluctuate.
- Geopolitical dynamics can result in the withdrawal of support from institutional investors and lead to poor stock performance.
- Investors can face higher levels of risk related to visibility on business operations and the reliability of reported financial results.
Taxes on international stock investments
International stocks may be subject to additional tax requirements beyond the standard tax liabilities that come with stocks of U.S.-based companies. In some cases, shareholders may owe taxes to both the U.S. and the country in which the company is domiciled.
Taxes on international stocks will vary based on the rules of the underlying company's home country. This means there is no one-size-fits-all breakdown for how taxes on foreign companies are handled, and investors should familiarize themselves with the relevant tax structures before establishing significant positions in foreign equities.
U.S.-based investors will always owe taxes to the U.S. government on gains generated from international stocks, but they will also sometimes owe foreign taxes. The good news is that U.S. investors can either receive a tax credit or a deduction on foreign taxes that have been paid on international stocks. This avoids double taxation.
If a U.S. citizen owns shares of a foreign stock that pays a dividend, the payout will typically be taxed based on the rules of the country in which the company is located. On the other hand, investors usually don't have to do anything to fulfill this tax liability. Part of the dividend payment will automatically be withheld and transferred to the government of the country where the business is headquartered.
When U.S. investors look at the 1099-B form connected to the dividend paid by the international stock, they will see that they have received a tax credit. This effectively prevents the shareholder from having to pay taxes on the dividend to both the U.S. and the country where the company is located.
Key differences between international and U.S. stocks
International companies with stocks that primarily trade on foreign exchanges may have different financial auditing, reporting, and visibility requirements compared to U.S. stocks that are subject to requirements put in place by the Securities and Exchange Commission (SEC). Because of these differences, international stocks can come with added risks that investors need to consider.
International stocks may also not trade directly on major U.S. exchanges. Instead, these stocks may be available to U.S. investors through American Depositary Receipts or traded over the counter.
For instance, many countries in Latin America have seen inflation levels even higher than in the U.S. and relatively weak economic recoveries on the heels of the coronavirus pandemic. While foreign stocks often trade at low price-to-earnings (P/E) and price-to-sales (P/S) multiples relative to comparable domestic companies, they also tend to be even more sensitive to macroeconomic shifts. The current backdrop suggests plenty of potential for volatility.
Foreign companies are also more likely to fail to meet most U.S. investors' communications and reliability expectations. Even foreign companies approved by the SEC to list ADRs on U.S. exchanges sometimes fail to meet reporting expectations. It's vital to understand how well and by what means an international company communicates with investors.
Before investing in international stocks, consider how much risk you're comfortable with. While emerging markets grow faster, they also tend to be more volatile, so you may prefer to focus on developed economies. By establishing a clear strategy for your non-domestic portfolio, you are better positioned to endure market turbulence and pursue long-term gains.
Key trends in international stocks
While international stocks as a broad category have underperformed U.S. stocks in recent decades, international stocks have recently been outperforming in a big way. Here are some of the trends that have contributed to strong returns for international stocks over the last year.
- Geographic diversification momentum: After a long stretch in which U.S. stocks dramatically outperformed international stocks, investors have been aiming to identify market inefficiencies and opportunities that can deliver strong returns. A combination of domestic and international political dynamics has caused some investors to increase their exposure to companies based outside the U.S., and continued weakening of the U.S. dollar has also supported growth for foreign investments.
- Diversification away from the "Magnificent Seven": The Magnificent Seven companies have played a huge role in powering gains for the broader market over the last five years. These companies have generally been delivering strong sales and earnings growth, and their leading positions in artificial intelligence have helped support bullish momentum. On the other hand, investors are also weighing valuation risks and looking for opportunities that could deliver the next stretch of big returns -- and that's encouraged bullish trading on top international stocks.
- Diversification away from other U.S. software stocks: In conjunction with concerns about AI-related disruption, U.S. software stocks have been facing strong valuation pressures. Some of the investment capital flowing out of these companies has rotated into international stocks in the fintech and industrials sectors. U.S. software stocks have traditionally commanded valuation premiums compared to international software stocks, but international tech stocks have been seeing valuation support as investors seek out companies that still offer appealing deals from a valuation perspective.
