Investing in Global Markets
Diversify across international developed and emerging economies, currency fluctuations, and foreign tax withholding credits.
TL;DR
- Diversify geographic portfolio risk across
developed-and-emerginginternational economies. - Factor in unhedged foreign
currency-exchangefluctuations on total dollar returns. - Claim the IRS
foreign-tax-creditfor taxes withheld on overseas dividends.
Developed vs Emerging Markets
Developed Economies (EAFE)Stable rule of law, mature financial systems (Europe, Australasia, Far East).
Stable rule of law, mature financial systems (Europe, Australasia, Far East).Emerging Market EnginesHigh demographic GDP expansion paired with institutional volatility.
High demographic GDP expansion paired with institutional volatility.Frontier MarketsPre-emerging economies offering extreme early-stage growth runways.
Pre-emerging economies offering extreme early-stage growth runways.Currency Fluctuation Dynamics
Unhedged Currency ExposureDollar returns equal local equity gains plus foreign currency changes.
Dollar returns equal local equity gains plus foreign currency changes.Strong Dollar HeadwindA rallying US Dollar reduces translated foreign investment gains.
A rallying US Dollar reduces translated foreign investment gains.Currency Hedged ETFsUsing forward contracts to neutralize foreign exchange fluctuations.
Set currency hedged etfs to local stock return.Access Vehicles: ETFs And ADRs
Total International ETFs (VXUS)Single-ticker global equity basket holding over 8,000 non-US companies.
Set total international etfs (vxus) to total equities times 0.30.American Depositary ReceiptsDirect dollar-denominated trading of foreign corporations on US exchanges.
Direct dollar-denominated trading of foreign corporations on US exchanges.Single Country FundsTargeted sovereign ETFs capturing individual nation growth trajectories.
Targeted sovereign ETFs capturing individual nation growth trajectories.Taxation And Withholding Credits
Foreign Withholding TaxesForeign governments deduct 15% to 30% on dividend distributions at source.
Foreign governments deduct 15% to 30% on dividend distributions at source.IRS Form 1116 CreditOffset foreign taxes paid dollar-for-dollar against US tax obligations.
Offset foreign taxes paid dollar-for-dollar against US tax obligations.Account Location StrategyKeep foreign funds in taxable accounts to preserve foreign tax credits.
Keep foreign funds in taxable accounts to preserve foreign tax credits.Tips
- Hold international index funds in taxable brokerage accounts to claim the IRS
foreign-tax-crediton Form 1116. - Allocate between 20% and 40% of your total equity portfolio to non-US
international-stocksfor balanced global diversification.
Warnings
- Beware of severe
currency-devaluationwhich can completely erase strong local stock market gains for US dollar investors. - Never ignore emerging market geopolitical
sovereign-risksincluding sudden capital export restrictions or corporate expropriation.
In Practice
Calculate the net US dollar return of an international equity investment following local appreciation and foreign currency depreciation.
A US investor buys $10,000 in European equities which rise 10% in local Euros while the Euro weakens 5% against the US Dollar.
- 1. Calculate local asset gain in Euros: 10,000 EUR * 1.10 = 11,000 EUR (+10.0% local return).
- 2. Initial currency exchange rate: 1.10 USD per EUR ($11,000 USD starting basis).
- 3. Euro currency depreciates 5% against USD: New rate = 1.10 * (1 - 0.05) = 1.045 USD per EUR.
- 4. Convert ending asset value to USD: 11,000 EUR * 1.045 USD/EUR = $11,495 USD.
- 5. Calculate net USD total return: ($11,495 - $11,000) / $11,000 = +4.50% net return.
Currency depreciation cuts the 10.0% local equity gain to a 4.5% net USD return.
Unhedged currency movements significantly alter dollar returns on foreign equity investments.
FAQ
Developed markets (like the UK, Japan, and Germany) feature mature economies, high per capita income, and advanced regulatory systems. Emerging markets (like India, Brazil, and China) exhibit faster economic growth but higher political, currency, and governance volatility.
An ADR is a certificate issued by a US bank representing shares in a foreign corporation, enabling US investors to trade foreign equities on domestic exchanges in US dollars without navigating foreign exchanges.
When foreign governments withhold taxes on overseas dividends paid to US investors, the IRS provides a dollar-for-dollar tax credit on your federal tax return, preventing double taxation of foreign corporate dividends.