You can make a strong and logical argument for investing overseas but unfortunately there are a number of likely pitfalls which many investors ignore.
Firstly let’s look at typical reasons why you might want to invest outside Australia.
We are a relatively small part of the world economy. We’re the sixteenth largest OECD economy as measured by Gross Domestic Product. (Interestingly on a per head of population basis our GPD is the sixth largest.)
In 2012 the Australian Stock Exchange was the eighth largest stock exchange as measured by market capitalisation. However this only represents about 2.4 per cent of all the world’s markets. The largest stockmarket is the United States and it makes up 36 per cent of the world’s markets as measured by market capitalisation.
It’s worth mentioning that on a population basis we make up just 0.3 per cent of the world’s population which means our economy and sharemarket definitely punch above their weight.
Logically there has to be many more businesses and investment opportunities outside Australia than inside this country. In fact we can all name many household businesses listed overseas but not here.
National economies don’t all perform well or poorly at the same time, so it can make sense to diversify where our money is invested so that all our savings aren’t exposed to one economy or, more particularly, one business. We then suffer the consequences if that economy or business goes through a bad patch.
Now let’s turn our attention to the pitfalls of investing outside Australia.
The first reason to be cautious is the volatility of the Australian dollar. Our currency is the fifth most traded currency and its value changes because of speculation and economic activity.
It’s not often realised that when the dollar declines the value of our international investments increase in Australian dollar terms. The exact opposite occurs when the dollar’s exchange rate increases.
The movement in the dollar can have a dramatic impact on our investment holdings. The graph covers a 400 month period from April 1980 until May 2014. It shows the percentage change in the Australian and US dollar exchange rate at the beginning of each month. In other words all the intra-month variability has been removed.
If you intend to have that income brought into Australia then the real amount you receive is at the mercy of the Australian dollar. Some people solve this problem by leaving foreign investment income overseas and then using that money when they visit a particular location.
Retirees with super fund account based pensions which need to regularly use the market value of their fund’s assets for minimum income calculations can find forward planning on how much income they will be paid very difficult because of the variability in the exchange rate means predicting their actual income in Australian dollars is almost impossible.
One way to solve the problem of exposure to exchange rate volatility is by hedging this risk which removes the changes in an investments value caused by currency movements. The cost of hedging can vary from 0.05 percent up to 0.2 per cent per annum.
Another feature of overseas shareholdings is dividend payments. On the whole Australian based companies pay out more of their profits as dividends than overseas based businesses. Many overseas businesses never pay dividends (for example, Warren Buffet and Charlie Munger’s Berkshire Hathaway) or at best a smaller one compared to similar Australian businesses.
Australian and foreign income tax laws and if relevant, double tax agreements, need to be considered.
Because accessing some overseas markets directly is hard some investors use managed funds which combine all income and capital gains and losses in one unit price which is valued at current market values.
Before investing you might like to receive financial advice about your personal circumstances. You should consider seeking advice from a licensed financial adviser. Before doing so you should watch our video, Financial Advisers: The Facts and the Fiction.
ADF Financial Services Consumer Centre