When a stock rises 17 times in 15 days, what happens? You jump in after the 15th day, of course! That is the story of GME (the stock ticker for American electronics games retailer Gamestop) and that of hordes of Indian investors entering the U.S. market – kickstarting their equity journey with a ‘foreign stock’. And how? After reading about it in Reddit groups!
No doubt investing in a foreign country can help diversify your portfolio. And specifically, when it comes to investing in the U.S., in stocks of companies you find value in everyday life (Google or Apple or Netflix). The question is, which route to investing in the U.S. is prudent and how much can you expose yourself to a market you know little about. So, here are things you need to know before investing internationally.
First, choosing a foreign stock is no different from choosing an equity share locally. The company’s business and financial fundamentals, moat, quality of balance sheet and governance, all matter. If not, foreign stocks too can go down to being penny stocks and destroy your wealth.
Next, you should know which markets to choose. A market that behaves like India may not offer any diversification. So, you need to choose markets that are less correlated or those that offer different opportunities.
Your gains from international investing come from the local market returns plus the currency movement.
For example: The annualised five-year return of the Nasdaq 100 index (as of March 12, 2021) was 25%, as opposed to the 26.5% return of an Indian fund that invests in the same index. Clearly, the additional returns came from the rupee depreciation. But the reverse can also be true in that you may have lower returns if the rupee appreciates. So, currency movements can benefit or harm you.
You need to be aware of the upfront costs, recurring costs, and taxation when it comes to investing internationally.
First, the exchange rate spread when you buy foreign currency may not work in your favour as the currency exchange fee you are charged for this by your bank/broker may not be competitive at all. This is the upfront cost you incur — somewhat like an entry load as one fund manager put it.
Second, know your tax laws. 2020 saw a new rule of tax collection at source for foreign remittances above ₹7 lakh, at 5%. While this can be claimed in your tax returns, you should be aware that it is a cash outflow for you if you are investing large sums.
Third, you should be aware of the tax treatment including dividends or capital gains and inheritance tax in the country in which you are investing. In India, the gains from listed foreign stocks are taxed differently from local equity shares. If held for more than two years, it is considered long-term and taxed at 20%. Otherwise, it is called a short-term gain and taxed at your slab rate. In the fund route, they are treated like debt funds for tax purposes. Dividends too are taxed. You might need an auditor to help you with all these complexities and her/his fees is an additional charge too!
Fourth, brokerage expenses on purchase or sale of foreign stocks is not as low as it is locally. This is because your local broker is typically associated with a foreign broker and that brings the cost of intermediary into your total cost.
Apart from the cost, you also need to be aware of the pedigree of the international brokers, their registration with the foreign country’s regulator, apart from the local firm’s history (as there are many new start-ups in this field).
The above points notwithstanding, there is no denying that your portfolio will stand enriched if you add some international flavour to it. Instead of going the stock route, taking the ETF/passive fund route, especially in the U.S., can fulfil multiple needs.
One, you need not burn your fingers choosing stocks that may go bust. Two, passive investing is known to beat active funds most of the time in the U.S., and the country has an enviable range of ETFs. Three, you can do this through the direct investing route (buy ETFs through brokers) or easier still, use Indian funds that invest in such indices in the U.S. The latter is hassle-free as you invest in rupees (there is no remittance involving you) and yet gain from any currency depreciation. The expense is quite low (less than 0.5%), and you don’t even need a broker account if you use the fund route.
Instead of complying with FEMA, RBI’s Liberalised Remittance Scheme (LRS) and the taxman’s law, isn’t this a simpler route?
But some caveats apply. As with everything, excess of anything is bad. So, keep your exposure at 10-20% of your portfolio. Second, as is the rule with equities, don’t make a beeline seeing high returns. That’s poor timing. Third, you should invest only to diversify; not with the intent of earning higher returns than India. The GME rocket can come crashing down in flames too!
(The writer is Co-founder, PrimeInvestor.in)