4 Ways to Invest in the European Stock Market
International investing might be easier than you think
A more connected global economy, widespread access to information, and deregulation in the financial markets have made it easier to diversify your investment portfolio without breaking the bank. For many investors, prudent diversification has meant more than just paying attention to balancing asset class exposure or carefully choosing different sectors or industries in which to make an investment, extending to geographic diversification as well.
In the United States, this has sometimes meant looking beyond the amber waves of grain to the capital markets of other countries and regions, with Europe being a particularly attractive choice thanks to the fact that it is home to many of the world's preeminent corporations—businesses that have rewarded owners with decade after decade of capital appreciation and dividends.
If you aren't familiar with international investing, this begs the question: How, precisely, do you invest in the European stock market? For a broad, general overview of some of the ways different people might approach this task, here are four methods an investor or his or her portfolio manager or financial advisor might go about adding foreign stocks from across the Atlantic to a well-constructed basket of holdings.
Purchase Specialized Mutual Funds and ETFs
This method of investing in European stocks is particularly useful for investors without a lot of capital. By investing in mutual funds or exchange-traded funds (ETFs) that restrict their components to companies headquartered—or that do a large percentage of business—within European countries, you can get the benefits of widespread diversification at a lower cost than you otherwise might be able to achieve by attempting to build the positions directly.
Investing through a pooled vehicle such as an index fund, whether structured as a traditional mutual fund or exchange-traded fund, comes with downsides. On one hand, you often have significant unrealized capital gains that are lurking in the portfolio. Under a lower-probability scenario, there exists a series of events that could lead to you paying substantial taxes on someone else's past gains—a technical point that most investors don't even realize exists with funds. Perhaps more pressing is the fact that you have to take the good with the bad, including dealing with the underlying sector and industry weightings of the fund portfolio.
Acquire American Depository Receipts
Another way to invest in the European stock market is to buy foreign stocks through American Depository Receipts (ADRs). An ADR depository bank, usually a subsidiary of a large financial institution, purchases a block of foreign stock directly. It then puts this foreign stock on its books and issues securities representing ownership of it, with those securities trading in the domestic market, usually on the Over-the-Counter (OTC) market so individual investors can buy and sell shares just as they might a domestic stock—go online, enter the ticker symbol, review the trade, and submit it to your broker.
The difference is that the ADR depository bank collects any dividends, converts them to U.S. dollars, distributes them to the ADR owners, and then charges small ADR fees.
Often, the ADR depository bank handles foreign tax treaty filings, too, so the lower 15 percent withholding rate will be taken from dividends rather than the higher 35 percent, but you can't always count on that. Sometimes, ADR are sponsored by the foreign company itself, in which case the ADR will have better transparency and submit certain regulatory filings that it otherwise would not have to submit. In other cases, the ADR is not sponsored by the company but, instead, was created because the ADR custody bank thought there was a market for the security and that it could generate fee income by offering access to the stock.
One challenge when dealing with ADRs is that many financial portals don't specify if they are reporting the dividend, and the dividend yield, based on the gross pre-tax dividend, as is done with domestic securities, or on the net-of-tax dividend after foreign dividend withholding (and if the latter, at which rate). This means you need to make some adjustments to arrive at an apples-to-apples dividend comparison. Another drawback is that ADR programs might be modified or change in ways you neither anticipated nor like.
On the other hand, a nice feature of ADRs is that you can usually shatter them and take possession of the underlying foreign stock if you decide you would rather own it instead. This might involve paying a fee to your broker and the ADR depository bank.
Purchase Shares of European Stocks Directly
This method is the most direct, and usually the least familiar to American investors who have only owned domestic securities. For the sake of illustration, let's imagine that you decide you want to own shares of a large chocolate company in Switzerland.
The specifics of how to go about buying shares differ depending upon the brokerage firm you are using to execute your trades. But for a majority of retail investors, it will involve calling the broker's equity trading desk so an actual trader can walk you through the trade. They will handle exchanging your U.S. Dollars for Swiss Francs for settlement, charging a spread, and then tell you the final execution price along with the commission, which will usually involve an additional commission for the local broker in Switzerland with which your broker has a relationship.
When the shares appear in your brokerage account, they will be shown without a ticker symbol (or, at least, will have a ticker symbol that cannot be traded online). The shares will also be shown in the U.S. dollar equivalent, not the actual Swiss quoted price, meaning they can appear to fluctuate wildly even if they haven't actually changed quoted value on the Swiss stock exchange because the custodian, which is also likely to be your broker, is telling you what the stock would be worth if you sold the position and converted the resulting Swiss Francs back into U.S. dollars.
Equally as important, any dividends received in Swiss Francs are going to be automatically converted back into U.S. dollars, net of a spread for the currency translation, and deposited in the brokerage account. Foreign taxes to the government of Switzerland will also be withheld, usually at a rate of 35 percent unless you go to the trouble of filing out a specific set of paperwork that claims your right as an American citizen, under a tax treaty between the United States and Switzerland, to opt for the lower 15 percent foreign dividend tax withholding rate.
Note that in rarer cases, your custodian might be able to show the quoted value of the Swiss shares in Swiss Francs, and allow you to hold multiple currencies in your account so that dividends arrive in Swiss Francs, too.
One drawback to this method of investing in European stocks is that it requires investing at least several thousand dollars per transaction for the added commissions and expenses to make sense. Also consider prioritizing buy-and-hold investments, because the currency translation costs make switching between positions more expensive.
Acquire Ownership in Domestic Companies With Significant International Market Exposure
There can be a tendency for investors, particularly those new to investing in common stocks, to mistakenly associate a company with the country in which it is headquartered. A good chunk of United States firms generate significant sales and profits internationally. In fact, the U.S. is quickly approaching the point at which half of the sales generated by the S&P 500 arise from activity outside of the United States.
This is to say that by investing in domestic blue-chip companies, you could very well be investing in Europe already without realizing it.
Jacara does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.