When comparing the returns of equity mutual funds, many foreign mutual funds outperform domestic ones. This has caused some investors to buy more securities in international companies in the hopes of huge returns. While these funds offer great diversification, you must also be aware of the pitfalls of foreign mutual funds.
What Are Foreign Mutual Funds?
Foreign mutual funds are international funds that invest in securities of foreign companies that are listed in foreign markets. Some mutual funds invest directly in international stock markets. Others serve as feeder funds that invest in specified mutual funds in international markets.
They can be categorized geographically or by the markets they invest in. Some international funds choose to focus on a single sector, commodity or emerging market.
Why Do People Invest in Foreign Markets?
One of the greatest advantages when investing in foreign markets is the instant diversification you receive. With these funds, you are buying a piece of larger portfolios than you couldn’t assemble on your own. Investing in foreign markets also diversifies your holdings into different currencies. Monetary depreciation between currencies increases your returns on investments in foreign markets as well.
Another benefit of foreign investment is exposure to new markets and economies. Varying markets and economies do not necessarily move in tandem with one another. Investing in foreign mutual funds allows you the chance to invest in other economies that are performing better at that particular time.
Finally, you get professional management for your portfolio backed by a full financial team. Fund managers have extensive experience in the global markets. Additionally, research analysts located worldwide are constantly looking at new investment opportunities for their firms.
What are the Pitfalls of Foreign Mutual Funds?
However, there are many pitfalls of foreign mutual funds. Before you run off and invest in an international fund, consider these drawbacks.
1. They charge annual management fees. The average international fund charges about 1.5% of the total assets, but some are much more expensive. This figure seems like a small amount but it can add up over time.
2. You have less control over decisions since your fund manager chooses where to invest. They may choose to focus on a different region than you prefer, or invest in different companies that you would not choose for yourself. Since they are only required to report holdings twice per year, you may not know the details of what your manager is buying until long after the fact. This is not always a bad thing, but many things are out of your hands
3. Not all international funds perform well. Furthermore, currency exchange rates could work against you as well. If the foreign currency appreciates instead, this can reduce your returns.
4. U.S. tax payers who invest in foreign mutual funds more heavily taxed for foreign mutual funds. Since the Tax Reform Act of 1986, investors can no longer cash in on the loophole related to tax-free foreign mutual funds.
Should You Invest in Foreign Mutual Funds?
In the end, the argument for global diversification in your portfolio is a compelling one. However, you must carefully weigh it against the pitfalls of foreign mutual funds. Should you choose to invest in foreign markets, it is always wise to proceed with caution. Don’t sink all your money into an unfamiliar market or ignore the risks of forex investments. As with all financial matters, never invest money that you can’t afford to lose and seek professional advice when you feel out of your depth.
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